A DISSERTATION REPORT ON

ECONOMIC VALUE ADDED- VALUE CREATION IN POWER INDUSTRIES OF INDIA

(Submitted for the Partial Fulfillment of the Requirement for the Degree of Master in Business Administration)

UNDER THE GUIDANCE OF PROF. SASMITA GIRI Asst. Prof Finance, MBA Dept., IIPM - School of Management Kansbahal

SUBMITTED BY

NIRLIPTA PRIYADARSINI MISHRA REGD NO: 0906262055 MBA VI TRIMESTER, SESSION 2009 11

BIJU PATNAIK UNIVERSITY OF TECHNOLOGY, ODISHA.

DECLARATION

I Nirlipta Priyadarsini Mishra bearing Registration Number: 0906262055, a student of MBA(2009-2011) of IIPM-School of management, under BIJU PATNAIK UNIVERSITY OF TECHNOLOGY, Rourkela, Orissa do hereby declare that the Dissertation Report entitled Economic value added- Value creation in power industries of India is the outcome of my own work and the same has not been submitted to any University/Institute for the award of any degree or any Professional diploma.

Date-

Nirlipta Priyadarsini Mishra Regd. No : 0906262055 MBA 2009-2011

CERTIFICATE OF GUIDE

This is to certify that the work entitled Economic value added- Value creation in power industries of India is a Dissertation Report done by Nirlipta Priyadarsini Mishra student of MBA Trimester VI bearing Regd. No 0906262055 under my guidance and supervision for partial fulfillment of MBA curriculum of Biju Patnaik University Of Technology, Orissa.

To the best of my knowledge and belief the Summer Project Report : 1. Embodies the work of the candidate herself. 2. Has been duly completed. 3. Is up to the standard both in respect of contents and language for being referred to the examiner.

NAME OF THE STUDENT: Nirlipta Priyadarsini Mishra Registration No.: 0906262055 MBA- Trimester VI

Forwarded by:

GUIDE PROF. SASMITA GIRI Asst. Prof Finance, MBA Dept., IIPM - School of Management - Kansbahal

ACKNOWLEDGEMENT
On the completion of the project, I would like to express my heartfelt acknowledgement and deep sense of gratitude to the people who have helped me through the various stages of the development of this report. I owe a special thanks to the Biju Patnaik University of Technology for designing a course structure, which gives us the opportunity to visit an organization and study it closely which gives a practical insight to the students and immense knowledge. First and foremost I would like to thank Dr. Mihir Ranjan Nayak, director MBA, (IIPM School Of Management, Kansbahal). I very much appreciate and sincerely acknowledge suggestions from Prof. Sasmita Giri and her experience of this field along with her guidance. She has always been a source of incessant motivation and encouragement to me, and has always extended her complete support to me in making this project. Last but not the least, I would like to pay gratitude to my parents, without whose help and blessings I could not have taken a single step in the right direction. Submitted By: Nirlipta Pritadarsini Mishra MBA (2009-11) IIPM-SOM, Kansbahal

TABLE OF CONTENTS
CHAPTER PARA 1 2 1.0 2.0 2.1 2.1.0 2.1.1 2.1.2 2.2. 2.2.0 2.2.1 2.2.2 2.2.3 2.2.4 2.2.5 2.2.6 3 3.0 3.1 3.2 3.2.0 3.2.1 3.2.2 3.2.3 3.2.4 3.3 3.4 4 4.0 4.1 4.2 PARTICULARS Abstract Introduction To The Study Indian Power Sector Power Sector Classification Govt. policies and initiatives Growth of Power Sector in India Overview of EVA Economic profit is a performance credit Performance Measure EVA in Indian Context EVA- The concept EVA as a performance measure 4 Ms of EVA The 3 pillars of profit Literature Review Mathematically Components of EVA Calculating NOPAT Calculating Cost of capital Calculation of Ke Formula of Ke Measuring Capital Employed Application of EVA as better concept Rationale for using EVA Objective and Scope of the Study Objectives of the study Scope of the study PAGE NO 8 9-16 10 10 11 11 11 12 12 14 15 15 16 16 17-21 18 18 18 18 19 19 20 20 21 23 23 23

5.0 5.1 5.2 5.3 5.4 5.4.0 5.4.1 5.4.2

Research Methodology Study Type Sample Technique Sample Size Data collection Data type Data Content Data Source Analysis and Interpretation Findings and Recommendations Limitations of the study Conclusion Bibliography/References Annexure

24 24 24 24 24 24 24 24 25 29 30 31 32 33

6 7 8 9 10 11

6.0 7.0 8.0 9.0 10.0 11.0

TABLE OF CONTENTS FOR FIGURES AND TABLES

PAGE FIGURES PARTICULARS NO.

Growth in annual per capita consumption of electricity (in 25 Table 6.1 kwh) in fy05 to fy10 Growth in installed capacity in india since the sixth five year 25 Table 6.2 Table 6.5.0 Table 6.5.1 Table 6.5.2 Table 6.5.3 Table 6.5.5 Table 6.6 Table 6.7.0 plan. Calculation of nopat Calculation of wacc Analysis of beta Calculation of ke Analysis of wacc Calculation of capital employed Calculation of eva 27 27 28 28 28 29 29

TABLE OF CONTENTS FOR GRAPHS

PAGE FIGURES Graph 2.1.1 Graph 6.3 Graph 6.4 Graph 6.5.0 Graph 6.5.1 Graph 6.5.2 Graph 6.7.0 PARTICULARS Growth in power generation in india fy01 to fy10 Growth in power generation in india fy01 to fy10 Growth in power demand-supply in india in fy01 to fy10 Calculation of NOPAT Calculation of WACC Analysis of BETA Calculation of EVA NO. 11 25 25 27 28 28 29

1.0 ABSTRACT

The value-based management performance measure EVA introduced by Stern Stewart & Co. is an incarnation of the underlying residual income (RI) concept. The concept is evaluated and compared with traditional profitability measures within a controlled simulation framework. It is observed that EVA is very sensitive to its cost of equity component, but it is unexpectedly insensitive to its cost of debt component under regular conditions. EVA and its variability are observed to be strongly affected by the firm's growth policies because of leverage effects. EVA is observed to be much more unstable than the traditional return on investment and directly related to the return on equity measure. Methodologically, the paper demonstrates the advantages of using a controlled simulation approach in financial research. The EVA is computed of 20 companies of the NIFTY for a period of 6 years beginning from FY 2004-05 to FY 2009-10. EVA is equal to NOPAT (Net Operating Profit) minus WACC (Weighted Average Cost of Capital). NOPAT is EBIT after taxes. Cost of equity is calculated using CAPM Model. Beta is calculated based on monthly high low average of past three years. From the study it is observed that there is no strong pattern of wealth created by companies. EVA of different companies varies year to year based on its overall cost of capital and cost of equity is more influential factor. It is also found that EVA and market price has no good relation for the sample companies. And thus we can say that investors do not consider EVA for the investment decision.

2.0 INTRODUCTION TO THE STUDY EVA is a value based financial performance measure, an investment decision tool and a performance measure reflecting the absolute amount of shareholder value created. It is computed as the product of the excess return made on an investment or investments and the capital invested in that investment or investments. EVA is the net operating profit minus an

appropriate charge for the opportunity cost of all capital invested in an enterprise or project. It is an estimate of true economic profit, or the amount by which earnings exceed or fall short of the required minimum rate of return investors could get by investing in other securities of comparable risk (Stewart, 1990). EVA is not new. Residual income, an accounting performance measure, is defined to be operating profit with a capital charge subtracted. Thus, EVA is a variant of residual income, with adjustments to how one calculates income and capital. Stern Stewart & Co, a consulting firm based in New York, introduced the concept of EVA as a measurement tool in 1989, and trademarked it. The EVA concept is often called Economic Profit (EP) to avoid problems caused by the trade marking. EVA is so popular and well known that all residual income concepts are often called EVA even though they do not include the main elements defined by Stern Stewart & Co (Pinto, 2001). Up to 1970 residual income did not get wide publicity and it was not the prime performance measure for companies (Makelainen, 1998). However, in the 1990s, the creation of shareholder value has become recognized as the ultimate economic purpose of a corporation. Firms focus on building,

operating and harvesting new businesses and/or products that will provide a greater return than the firms cost of capital, thus ensuring maximization of shareholder value. EVA is a strategy formulation and a financial performance management tool that helps companies make a return greater than the firms cost of capital. Firms adopt this concept to track their financial position and to guide management decisions regarding resource allocation, capital budgeting and acquisition analysis. Economic Value Added simply balances a company's profitability against the capital it employs to generate this profitability. If a company's earnings, after tax, exceed the cost of the capital employed in the business, EVA is positive. Market studies have indicated that a company that

continually generates an increasingly positive EVA will be rewarded by a higher stock price. A definition of EVA is net operating profit after taxes (NOPAT), less an internal charge for the capital employed in the business (i.e., opportunity cost of capital). Many of the traditional corporate performance measures have been found to poorly correlate, or even conflict, with management's primary objective of maximizing the market value of a firm's stock. Now, there are several new measures in the financial world that attempt to align the behaviors of an organization with its stockholders' interests. One measure that has received a great deal of notice and acceptance is Economic Value Added (EVA), developed by Joel M. Stern and G. Bennett Stewart III of Stern Stewart & Co. Implementation of one of these measures, such as EVA, can fundamentally change the behavior of an entire organization. The new measure focuses the behavior of individuals throughout all parts of the organization in a way that is better aligned with creating stockholder wealth. Because performance compensation incentives are based upon the new measure, employees and stockholders mutually benefit. The financial function is uniquely qualified to take a leadership role in communicating an understanding of the new measure. Main challenge is to gain a deep understanding of the underlying principles of the measure and to communicate them in a meaningful way to all parts of the organization. There can be pitfalls in translating the theory to practice, but there is an opportunity to provide the appropriate counsel.

From a commercial standpoint, Economic Value Added (EVA) is the most successful performance metric used by companies and their consultants. Although much of its popularity is a result of able marketing and deployment by Stern Stewart, owner of the trademark, the metric is justified by financial theory and consistent with valuation principles, which are important to any investor's analysis of a company. To many, the EVA metric (also known as "economic profit") basks in a mystique of complexity. But this tutorial will show you that this complexity is only an illusion. In fact, the entire metric is a development of three simple ideas: cash is king; some expense dollars are really investments in "disguise"; and equity capital is expensive. To help you understand EVA and its components, we devote each chapter of this tutorial to

exploring a different conceptual aspect of economic value added (EVA) and demonstrating the associated calculations .By the end of this tutorial, you will not only be able to calculate EVA for yourself, but also, importantly, understand its strengths and weaknesses, observing how it is ideal for some situations, but also - contrary to some dogma - not necessarily the best performance metric for many other situations. Because the term EVA is trademarked, for conveniences sake, we will instead refer to it as economic profit throughout the tutorial. This is a common practice and, for our purposes, there is no difference. A concept critical in evaluating the performance of any business is economic value added. In generic terms, value added refers to the additional or incremental value created by an activity or a business venture. Economic value added is a refinement of this concept it measures the economic rather than accounting profit created by a business after the cost of all resources including both debt and equity capital have been taken into account. Economic value added (EVA) is a financial measure of what economists sometimes refer to as economic profit or economic rent. The difference between economic profit and accounting profit is essentially the cost of equity capital an accountant does not subtract a cost of equity capital in the computation of profit, so in fact an accountants measure of income or profit is in essence the residual return to that equity capital since all other costs have been deducted from the revenue stream. In contrast, an economist charges for all resources in his computation of profit including an opportunity cost for the equity capital invested in the business so an economists definition and computation of the profit is net above the cost of all resources. It is now well settled that the aim of every business entity should be to maximize shareholders wealth by enhancing the firms value and all the activities of a firm should be directed to achieve this objective.

2.1 INDIAN POWER SECTOR 2.1.0 Power Sector Classification The power sector is classified into three categories:

Generation Distribution Transmission

2.1.0.1 Generation As on Mar 31 2010, Indias total installed generation capacity was 159,398.49 MW: 102,453.98 MW thermal, 36,863.4 MW hydro, 4,560 MW nuclear, and 15,521.11 MW of renewable energy sources (RES). State utilities contributed the maximum to Indias power generation followed by central and private sector utilities. Power generation capacity was highest in the western region followed by southern, northern, eastern, and north eastern regions. [ INSERT FIGURE 2.1.0.1 ] 2.1.0.2 Distribution Distribution of electricity has been privatized in Delhi and Orissa and 98% feeders and 88% consumers have been metered so far at the national level; 100% feeder metering has been achieved in 20 states. To strengthen and up-grade sub-transmission and distribution systems in centers with high-density load, Go launched Accelerated Power Development Reforms Programmer (APDRP) in FY03 for implementation in the Tenth Plan as additional central assistance to the states. The programme mainly aims to reduce AT&C and commercial losses and improve quality and reliability of supply. The programme has two components: investment and incentive.

2.1.0.3 Transmission Efficient transmission of power is another cornerstone in an ambitious power for all by 2012 initiative. Presently, the entire country has been divided in five major regions: north-eastern, eastern, western, southern and northern. The regions are operating as one synchronous grid with total generating capacity of 159,398 MW to facilitate flow of power from regions having surplus power to regions having deficit power supply. 2.1.1 Government Policies and Initiatives Goverment has taken various initiatives to improve electricity generation, distribution and transmission. Some of the prominent policies that encouraged PPP in the sector are:

National Electricity Policy Ultra Mega Power Project Policy Mega Power Policy Tariff Policy

Section 63 of the Electricity Act 2003 has provided impetus to participation of private sector in generation and transmission. As a result of these policy initiatives, out of planned capacity addition of 20,897 MW by the private sector during the Eleventh Plan, 19,897 MW addition is under progress and 1,000 MW has already been added to the countrys energy basket. In addition, a large number of IPPs have also applied for coal linkage of nearly 187,000 MW. After the enactment of the Electricity Act, a major step was unbundling of SEBs. This brought in the muchneeded focus to each segment generation, transmission and distribution. As of now, 14 states have reorganized their SEBs. 2.1.2 GROWTH OF POWER SECTOR IN INDIA The power sector plays a significant role in the countrys overall economic development and is a critical infrastructure component that ensures socio-economic development of the country. The power sector is expected to grow exponentially in keeping with target of providing electricity to

all households in the next five years. It also aims to increase per capita availability of electricity to more than 1,000 units and fully meet demand for power by 2012. INDIAN POWER SECTOR The power sector has registered significant progress since the process of planned development of the economy began in 1950. Hydro -power and coal based thermal power have been the main sources of generating electricity. Nuclear power development is at slower pace, which was introduced, in late sixties. The concept of operating power systems on a regional basis crossing the political boundaries of states was introduced in the early sixties. In spite of the overall development that has taken place, the power supply industry has been under constant pressure to bridge the gap between supply and demand. Growth of Indian power sector Power development is the key to the economic development. The power Sector has been receiving adequate priority ever since the process of planned development began in 1950. The Power Sector has been getting 18-20% of the total Public Sector outlay in initial plan periods. Remarkable growth and progress have led to extensive use of electricity in all the sectors of economy in the successive five years plans. Over the years (since 1950) the installed capacity of Power Plants (Utilities) has increased to 89090 MW (31.3.98) from 1713 MW in 1950, registering a 52d fold increase in 48 years. Similarly, the electricity generation increased from about 5.1 billion units to 420 Billion units 82 fold increase. The per capita consumption of electricity in the country also increased from 15 kWh in 1950 to about 338 kWh in 1997-98, which is about 23 times. In the field of Rural Electrification and pump set energisation, country has made a tremendous progress. About 85% of the villages have been electrified except farflung areas in North Eastern states, where it is difficult to extend the grid supply. Structure of power supply industry In December 1950 about 63% of the installed capacity in the Utilities was in the private sector and about 37% was in the public sector. The Industrial Policy Resolution of 1956 envisaged the generation, transmission and distribution of power almost exclusively in the public sector. As a

result of this Resolution and facilitated by the Electricity (Supply) Act, 1948, the electricity industry developed rapidly in the State Sector. In the Constitution of India "Electricity" is a subject that falls within the concurrent jurisdiction of the Centre and the States. The Electricity (Supply) Act, 1948, provides an elaborate institutional frame work and financing norms of the performance of the electricity industry in the country. The Act envisaged creation of State Electricity Boards (SEBs) for planning and implementing the power development programmes in their respective States. The Act also provided for creation of central generation companies for setting up and operating generating facilities in the Central Sector. The Central Electricity Authority constituted under the Act is responsible for power planning at the national level. In addition the Electricity (Supply) Act also allowed from the beginning the private licensees to distribute and/or generate electricity in the specified areas designated by the concerned State Government/SEB. During the post independence period, the various States played a predominant role in the power development. Most of the States have established State Electricity Boards. In some of these States separate corporations have also been established to install and operate generation facilities. In the rest of the smaller States and UTs the power systems are managed and operated by the respective electricity departments. In a few States private licencees are also operating in certain urban areas. From, the Fifth Plan onwards i.e. 1974-79, the Government of India got itself involved in a big way in the generation and bulk transmission of power to supplement the efforts at the State level and took upon itself the responsibility of setting up large power projects to develop the coal and hydroelectric resources in the country as a supplementary effort in meeting the countrys power requirements. The National thermal Power Corporation (NTPC) and National Hydroelectric Power Corporation (NHPC) were set up for these purposes in 1975. North-Eastern Electric Power Corporation (NEEPCO) was set up in 1976 to implement the regional power projects in the North-East. Subsequently two more power generation corporations were set up in 1988 viz. Tehri Hydro Development Corporation (THDC) and Nathpa Jhakri Power Corporation (NJPC). To construct, operate and maintain the inter-State and interregional

transmission systems the National Power Transmission Corporation (NPTC) was set up in 1989. The corporation was renamed as POWER GRID in 1992.

2.2 OVERVIEW OF EVA

Examining the components of economic profit and studying the finer points of its calculation require an understanding of its underlying principles. Here we look at how it matters as a performance measure - which is distinct from a wealth metric - and how it is closely related to market value added (MVA). Finally, in establishing an overall picture of economic profit, we help you undo any perceived complexity by showing how all of the calculations surrounding economic profit originate from three main ideas.

2.2.0 Economic profit is a performance metric

To understand economic profit, it helps to distinguish between a performance metric and a wealth metric. A performance metric refers to a measure under company control, such as earnings or return on capital. A wealth metric, on the other hand, is a measure of value that such as equity market capitalization or the price-to-earnings (P/E) multiple -depends on the stock market's collective and forward-looking view. Now, although these two types of metrics are distinct, they are related. Every performance metric has a corresponding wealth metric. In theory, over the long run, a performance metric can be expected to impact its corresponding wealth metric. For example, consider the matching pair of earnings per share (EPS), a fundamental performance metric, and the P/E multiple, its corresponding wealth metric. The variables that determine EPS earnings and shares outstanding - are numbers affected only by the company's actions and decisions. On the other hand, the P/E multiple, which is determined by the company's stock price, depends on the value of these actions and decisions assigned by the stock market. The company therefore influences the P/E ratio but cannot fully control it. Here is

another way to think about the difference between the two: EPS is a current (or historical) fact but P/E is a forward-looking and collective opinion. The key criterion for the pairing of a performance and wealth metric is consistency: each half of the pair should reference the same group of capital holders and their respective claims' on company assets. For example, EPS by definition concerns the allocation of earnings to common shareholders; the P/E multiple refers to equity market capitalization, which is the value held by shareholders. Consider another example: return on capital (ROC) is a performance metric that represents the return both to debt and stockholders, and its corresponding wealth metric is the EBITDA multiple - the value of total debt, plus equity market capitalization (also known as the "enterprise value" or "entity value"), divided by earnings before interest, taxes, depreciation and amortization (EBITDA). This is also called the "price-to-EBIDTA multiple", or "the enterprise multiple". Note how ROC and the EBITDA multiple meet the consistency test. Like ROC, EBITDA captures earnings that accrue to both holders of stock and debt. The EBITDA multiple, therefore, reveals how the market values the company in light of earnings to stockholders and debt-holders. Below is a chart listing a few performance metrics and their corresponding wealth metrics. Note that economic profit's corresponding wealth metric is market value added (MVA).

2.2.1 Performance Measurement

Investors measure overall performance of a firm as a whole to decide whether to invest in the firm or to continue with the firm or to exit from it. In order to achieve goal congruence, managers compensation is often linked with the performance of the responsibility centers and also with firm-performance. Therefore selection of the right measure is critical to the success of a firm. To measure performance of a firm we need a simple method for correctly measuring value created/ enhanced by it in a given time frame. All the current metrics trade off between the precision in measuring the value and its cost of measurement. In other words, each method takes into consideration the degree of complexities in quantifying the underlying measure. The more complex is the process, the more is the level of subjectivity and cost in measuring the performance of the firm. There is a continuous endeavor to develop a single measure that captures the overall performance, yet it is easy to calculate. Each metric of performance claims its superiority over others. Performance of a firm is usually measured with reference to its past

record and the performance of other firms with comparable risk profile. The various performance metrics currently in use are based on the returns on investment generated by the business entity . Therefore to reach a meaningful conclusion, returns generated by the firm in a particular year should be compared with returns generated by assets with similar risk profile (cross sectional analysis). Similarly return on investment for the current period should be compared with returns generated in past (time series analysis). A firm creates value only if it is able to generate return higher than its cost of capital. Cost of capital is the weighted average cost of equity and debt(WACC).

The performance of a firm gets reflected on its valuation by the capital market. Market valuation reflects investors perception about the current performance of the firm and also their expectation on its future performance. They build their expectations on the estimated growth of the business in terms of return on capital. This results in incongruence between current performance and the value of the firm. Even if the current performance is better in relative terms, poor growth prospects adversely affects the value of the firm. Therefore any metric of performance, to be effective, should be able to not only capture the current performance but also should be able to incorporate the direction and magnitude of future growth. Therefore the robustness of a measure is borne out by the degree of correlation the particular metric has with respect to the market valuation. Perfect correlation is impossible because as shown by empirical researchers, fundamentals of a company cannot fully explain its market capitalization; other factors such as speculative activities, market sentiments and macro-economic factors influence movement in share prices. However the superiority of a performance metric over others lies in providing better information to investors. Metrics of performance have a very important and critical role not only in evaluating the current performance of a firm but also in achieving high performance and growth in the future. The metrics of performance have a variety of users, which include all the stakeholders whose well being depends on the continued well being of the firm. Principal stakeholders are the equity holders, debt holders, management, and suppliers of material and services, employees and the end-users of the products and services. Value creation and maximization depends on the alignment of the various conflicting interests of these stakeholders towards a common goal. This means maximization of the firm value without

Jeopardizing the interests of any of the stakeholders. Any metric, which measures the firm value without being biased towards any of the stakeholders or particular class of participants, can be hailed as the true metric of performance. However it is difficult, if not impossible, to develop such a metric. Most of the conventional performance measures directly relate to the current net income of a business entity with equity, total assets, net sales or similar surrogates of inputs or outputs. Examples of such measures are return on equity (ROE), return on assets (ROA) and operating profit margin. Each of these indices measure a different aspect of performance, ROE measures the performance from the perspective of the equity holders, ROA measures the asset productivity and operating profit margin reflects the margin realized by the firm at the market place. The net income figure in itself is dependent on the operational efficiency, financial leverage and the ability of the entity to formulate right strategy to earn adequate margin in the market place. It is important to note that none of these measures truly reflect the complete picture by themselves but have to be seen in conjunction with other metrics. These measures are also plagued by the firm level inconsistencies in the accounting figures as well as the inconsistencies in the valuation methods used by accountants in measuring assets, liabilities and income of the firm. Accounting valuation methods are in variance with the methods that are being used to value individual projects and firms. The value of an asset or a firm, which is a collection of assets, is computed by discounting future stream of cash flows. The net present value (NPV) is the surplus that the investment is expected to generate over the cost of capital. Measures of periodical performance of a firm, which is the collection of assets in place, should follow the same underlying principles. Economic value added (EVA) 2 is a measure that captures the valuation principles.

2.2.2 EVA IN INDIAN CONTEXT

In India EVA is being used with impunity. A case at point is the study published by Economic times (11th December 2000) ,on corporate performance. While computing EVA it used a flat rate of 15 percent as the cost of capital of all the enterprises included in the study. The study explains that an average 15 percent interest for both the years covered by the study is used as it is almost equal to the prime-lending rate of the commercial bank and financial institution. It is a basic

principle of economics that higher the risk higher is the expected return. By estimating WACC at 15% this basic principle is violated. It may be argued that cost of debt should be taken post-tax and therefore effective cost of equity incorporated in the calculation is higher than 15 percent. Even if this argument is accepted the computation cannot be defended because the cost of capital is estimated without using any accepted economic model. Moreover by using a flat rate, variation in risk profiles of firms have been ignored. This shows both the popularity of EVA in India and difficulties in measuring the same. The study has also ignored adjustments in capital and operating income suggested by proponents of EVA. 2.2.3 ECONOMIC VALUE ADDED THE CONCEPT

EVA is the most misunderstood term among the practitioners of corporate finance. The proponents of EVA are presenting it as the wonder drug of the millennium in overcoming all corporate ills at one stroke and ultimately help in increasing the wealth of the shareholder, which is synonymous with the maximization of the firm value. The attractiveness of the EVA lies in its use of cash flow and cost of capital that are determinant of the value of the firm. In the process, EVA is being bandied about with utmost impunity by all and sundry,which includes the popular press. The academic world in its turn has come up with various empirical studies which either supports the superiority of EVA or questions the claim of its proponents. Currently the empirical evidence is split almost half way. EVA is nothing but a new version of the age-old residual income concept recognized by economists since the 1770's. Both EVA and residual income concepts are based on the principle that a firm creates wealth for its owners only if it generates surplus over the cost of the total invested capital. So what is new? Perhaps EVA could bring back the lost focus on economic surplus from the current emphasis on accounting profit. In a lighter vein it can be said that in an era where commercial sponsorship is the ticket to the popularity of even the concept of god, the concept of residual income has not found a good sponsor until Stern Stewart and Company has adopted it and relaunched it with a brand new name of EVA. Technically speaking EVA is nothing but the residual income after factoring the cost of capital into net operating profit after tax. But this is only the tip of the iceberg as will be seen in the next few sections. The paper examines EVA both as a measure of overall performance and a management philosophy that helps to improve the productivity of resources.

2.2.4 The Utility of EVA: Better Decision-Making EVA clarifies the concept of maximizing the absolute returns over and above cost of capital in creating shareholders' wealth. Hence better investment decisions can be taken with above aim rather than maximizing percentage of ROl. Understanding of EVA enables monitoring of investment decisions closely not only at the level of corporate but at line staff as well. Fosters New Era of Corporate Control EVA points / centres can be created within an organization and these centres would have capital, revenue and expenditure issue attached to them. It helps identify value drivers and destroyers. Responsibility of positive EVA can be delegated at these centres. It questions the decisions harder.

Long-Term Thinking
Perhaps the biggest benefit of this approach is to get employees and managers to think and act like shareholders. EVA encourages long-term perspective among the managers and employees of organization. It emphasizes that in order to justify investments in the long run they have to produce at least a return that covers the cost of capital. In other case, the shareholders would be better off investing elsewhere. This approach includes that the organization tries to operate without the luxury of excess capital and it is understood that the ultimate aim of the firm is to create shareholder value by enlarging the product of positive spread multiplied with capital employed. The approach creates a new focus on minimizing the capital tied to operations. Firms have so far done a lot in cutting costs but cutting excess capital has been paid less attention.

Capital Allocation Tool EVA is a capital allocation tool inside a company as it sets minimum level of acceptable performance with regard to the rate of return in the long run This minimum rate of return is based on average (risk adjusted) return on equity markets. The average return is a benchmark that should be reached. If a company cannot achieve the average return, then the shareholders would be better off if they allocated the capital to another industry or another company. Bonus System EVA has provided a platform on which a flexible bonus payment system can be based. Employees will be paid bonus only when they earn at least equal to the cost of capital employed. This links the bonus with the end result and forces employees to act like shareholders. Proponents of bonus systems based on EVA have suggested that bonuses for corporate managers should always be tied to the long-term capital because short-term EVA can sometimes be manipulated upwards to the cost of long run EVA The long run can be incorporated into EVA-based bonuses, that is, by banking the bonuses. This would mean that when EVA is good, the managers earn a certain percentage of it, but the bonus should not be paid out of them entirely. If the periodic EVA is negative, then the bonus put in the bank is negative and it decreases the balance already earned. This exposes the managers partly to the risk the shareholders are used to bear. At the same time, it gives incentives to good performers and encourages the bad performers to improve their performance. For example, manager earns a bonus of an amount X of the annual salary for leading its centre to a positive EVA to the extent of 10% of capital employed. Out of the entire bonus, 50% can be paid out and the rest can be banked as entitlement if the next year EVA is not negative. In case the EVA next year is negative, the banked bonus can be reduced as disincentive for bad performance.

How Companies Have Used EVA Name Timeframe Use of EVA

The Coca-Cola Co. Early 1980s Focused business managers on increasing shareholder value AT&T Corp. 1994 Used EVA as the lead indicator of a performance measurement system that included "people value added" and "customer value added" IBM 1999 Conducted a study with Stern Stewart that indicated that outsourcing IT often led to short-term increases in EVA Herman Miller Inc. Late 1990s Tied EVA measure to senior managers' bonus and compensation system

2.2.5 EVA AS A PERFORMANCE MEASURE

Proponents of EVA argue that EVA is a superior measure as compared to other performance measures on four counts: it is nearer to the real cash flows of the business entity; it is easy to calculate and understand; it has a higher correlation to the market value of the firm and its application to employee compensation leads to the alignment of managerial interests with those of the shareholders, thus minimizing the supposedly dysfunctional behavior of the management. The last two merits can be considered as a reflection of the first two. If EVA truly represents the real cash flows of a business entity and it is easy to calculate and understand, then it automatically follows that it should be closely related to the market valuation and it should minimize the dysfunctional behavior of the management when used as an incentive measure. In other words, close relation to market valuation and convergence of managerial interests with

shareholders interests is a vindication of EVA as a superior metric. EVA as a performance measure looks into the efficacy of EVA both as an absolute measure in comparison with net income, residual income and similar measures as well as a ratio in relation with performance measures like ROE, ROA and Operating Profit Margin, which are commonly used by both managers and equity analysts alike. These measures are normally used internally by the management to evaluate employee performance, incentive calculation and investment decisions and externally by equity analysts to ascertain the performance and growth of the firm. Along with these measures valuation models like NPV, IRR, Payback period and Book rate of return are used both internally and externally by managers for investment decisions.

2.2.6 4 Ms of EVA

Stern Stewart describes four main applications of EVA with four words beginning with the letter M. Measurement EVA is the most accurate measure of corporate performance over any given period. Management System A firms true value comes in using EVA as the foundation for a comprehensive financial management system that encompasses all the policies, procedures, methods and measures that guide operations and strategy. The EVA system covers the full range of managerial decisions, including strategic planning, allocating capital, pricing acquisitions or divestitures, setting annual goals-even day-to-day operating decisions. Motivation To instill both the sense of urgency and the long-term perspective of an owner, Stern Stewart designs cash bonus plans that cause managers to think like and act like owners because they are paid like owners. Mindset When implemented EVA financial management and incentive compensation system transforms a corporate culture. By putting all financial and operating functions on the same basis, the EVA system effectively provides a common language for employees across all corporate functions.. 2.2.7 The Three Pillars of Profit

Costs what businesses pay for the inputs they require to produce saleable output Value - the creation of well being in the eyes of your customers Price what your customers pay for the output

3.0 LITERATURE REVIEW

The concept of Economic Profit was first innovated by the famous Economist Alfred Marshall in 1890. Stern Stewart & Companys Idea of measuring share holders wealth by calculating its EVA is tested for banks by many researchers. Parsuraman (2000) took 28 banks in 1998 and the study period was only one year . There he got 18 banks (64%) as having ve EVA . He also concluded EVA & Return On Assets (ROA) as highly correlated. Thampy & Baheti(2001) studied EVA metric of 12 Indian banks(4-private,8-public) and the period of study was 1995-98 i.e 3 years . They did not find the result to be encouraging. Several banks such as large public sector banks did not create any economic value for the period. High Non Performing Assets (NPA) and low employee productivity and some other institutional reasons in Public sector banks were suspected to precede negative EVA. Jahur & Riyadh ( 2002) 39 banks operating in Bangladesh for the year 2001. They calculated EVA using different approaches and ranked those banks according to different Financial parameters of measuring Performance where EVA was also one of the parameters. However they concluded by saying that correlation of EVA with ROA(Return on Assets),Net Profit, Deposit per Employ & profit per employee is moderate. EVA was concluded to be a better tool for measuring financial performance than others. Soral & Bhanawat (2009) took a sample of 14 public sector & 12 private sector banks listed in BSE and studied their EVA over 4 years (2003-04 to 2006-07). They found EVA Creation in Indian Banking Industry to be positive.EVA got to be significantly correlated with Operating profit of both the sectors and NOPAT of Private sector. As far as the adaptability of EVA in Banks are concerned, according to survey report of Satish & Rau(2009), 74% of the banking respondents feel its valuable to include EVA as it has a very important role in decision making as well as managing for particular section of stake holders. . Banerjee(1999) got EVA as one of the most important indicator of shareholders value creation and inclusion of EVA in their Annual Report was found to have direct impact on Stock prices . Latha Chari (2009) also agrees that inclusion of EVA & EVA like performance measurement system motivates managers for a better decision so that goal of Shareholder wealth maximization takes place.

Examining EVA as a corporate philosophy we intend to look at the efficacy of EVA when implemented at every level of managerial decision making process to encourage managers to

deploy resources only on value enhancing activities and to align the interests of shareholders with managers. This involves two things, one is linking managerial compensation package with EVA and second is to inculcate the culture of evaluating every action from the viewpoint that it should generate EVA. The ultimate outcome should be enhancement in the firm-value measured by the capital market. When EVA is used as a management philosophy, it results in the enhancement of productivity by continuously focusing on return vis--vis cost of capital. However as market discounts expected long term performance of the firm, any compensation that motivates enhancement of short term EVA, may not maximize the firm value. However with EVA culture, the firm as a whole focuses on the economic surplus and that definitely improves value enhancement process. Of course, this can be achieved even by implementing the other practices but the simplicity of EVA in communicating the very fundamental principle, that generation of surplus over cost of capital can only enhance the firm value, makes it a management technique superior to other planning and control techniques. We shall examine the appropriateness of this perception.

3.1 MATHEMATICALLY EVA= NOPAT (WACC x Capital employed)

Where; NOPAT = EBIT (1-T) WACC = D/V (1-T) Kd + E/V Ke D = Market value of firms debt E = Market value of firms equity = Market Capitalisation V = D+E T = Marginal tax rate Kd = i (1-T) Kd = Cost of debt i = Normalise interest rate Ke = Rf + beta ( Rm Rf ) Ke = Cost of equity by CAPM

Rf = Risk free rate of return Beta = Market volatility Rm = Market return Capital employed = Net worth

3.2 COMPONENTS OF EVA

3.2.0 Calculating Net Operating Profit After Taxes (NOPAT) NOPAT is easy to calculate. From the income statement we take the operating income and subtract taxes. Operating income is sales less cost of sales and less selling, general and administrative expenses.

3.2.1Calculating Cost of Capital WACC is weighted average cost of capital (equity and debt). WACC used in the calculations is at book value of equity and debt. Many businesses dont know their true cost of capital, which means that they probably dont know if their company is increasing in value each year. There are two types of capital, borrowed and equity. The cost of borrowed capital is the interest rate charged by the bondholders and the banks. Equity capital is provided by the shareholders. An investors expected rate of return on an investment is equal to the risk free rate plus the market price for the risk that is assumed with the investment. The risk of a company can be decomposed into two parts. An investor can eliminate the first component of risk by combining the investment with a diversified portfolio. The diversifiable component of risk is referred to as nonsystematic risk. The second component of risk is non-diversifiable and is called the systematic risk. It stems from general market fluctuations which reflect the relationship of the company to other companies in the market. The non-diversifiable risk creates the risk premium required by the investor. In the security markets the non-diversifiable risk is measured by a firms beta. The higher a companys non-diversifiable risk, the larger their beta. As the beta increases the investors expected rate of return also increases. (Levy, 1982)

3.2.2 Calculation of Ke It is calculated using the Capital Asset Pricing Model developed by Modigliani and Miller.

3.2.3 Ke=Rf+Beta (Rm-Rf) In CAPM, risk is defined by the concept of beta. Beta() is the non-diversifiable systematic risk coefficient. It reflects the movement of an individual security relative to the movement of the overall market return. It is defined as the covariance of the rate of returns of the stock and the market divided by the variance of the market rate of return. Here, the beta has been calculated by using the daily data on NSE Closing Index. Essentially, CAPM reveals if NSE Index moves up(down) by particular percentage, the prices of the individual security moves up(down) by the same percentage multiplied by the beta. The negative beta reflects the prices of individual security move opposite to the market. Higher the beta, higher is the sensitivity of the individual security with respect to the market.

Market rate of Return(Rm) Rm is the representative of all the securities in the market. Normally Rm is taken as the return figure of some market index like BSE 100, S&P CNX NIFTY, BSE BANKEX ETC. These indices take some representative companies of the maket, into account and thus named as market index. Rm is the return for the market. It is calculated by using the formula given below for the index values. Rm=Average of return on market for all the 6 years Return = Closing index value-opening index value * 100/Opening index value

Risk free rate of return rate of Return(Rf) This is the bench mark rate of return one may expect to have with zero risk. Return on government securities or T-bills of respective years is taken as risk free rate. Rf is he risk free rate, i.e., the rate of interest for 6-year government securities. These rates are obtained from the website of Reserve Bank of India.

Beta values for all the sample companies for all the 6 years are calculated by finding the

slope between log normal of share prices of all the companies and log normal of the index values. Log normal of the values is considered to remove abnormalities if any and convert them into normal distribution.

Kd is the effective cost of Debt, which is calculated by dividing the totat interest by the total debt.

3.2.4 Measuring Capital Employed Invested Capital is the total long term funds and includes equity shares and the total debt as at the end of the year. Accounting profits differ from economic profits. Under generally accepted accounting principles, most companies appear to be profitable. However, many actually destroy shareholder wealth because they earn less than the full cost of capital. EVA overcomes this problem by explicitly recognizing that when capital is employed it must be paid for. In financial statements, created using generally accepted accounting principles, companies pay nothing for equity capital. As discussed earlier, equity capital is very expensive. Economic profits are defined as total revenues less total costs, where costs include the full opportunity cost of the factors of production. The opportunity cost of capital invested in a business is not included when calculating accounting profits.

3.3 APPLICATION OF EVA AS BETTER CONCEPT

Ways to raise eva of the firm

A Stern Stewart team works closely with a steering committee of representatives from line and staff functions to adapt EVA to the client's unique culture and management practices. The EVA implementation process generally involves the following steps: Obtaining senior management commitment Evaluating corporate and financial strategy, position, and alternatives Understanding where, how and why value is created in your markets and company Defining an action based value improvement plan Re-engineering financial management to focus on value creation

Strengthening and aligning incentive compensation with value Educating line managers Communicating with investors

EVA Value-focused Decision Making To maximize shareholder wealth, decision makers at all levels must be value-focused. The market value of any firm is a function of its expected future performance, which in turn is a function of the effectiveness of management. Stern Stewart helps clients improve performance by better understanding the value inherent in their strategy and operations. Whether we are assessing the value of an acquisition target, analyzing the economics of a product portfolio, formulating the structure of a compensation plan, or introducing a new financial management framework, we approach all projects from one vantage point what strategy best maximizes the value creation of the business over time?

Managers Who Think and Act like Owners We believe the most effective way to motivate managers to make value-based decisions is to link their incentives to goals that relate directly to value creation itself. Under this type of incentive structure, managers stand to gain substantially when, for example, EVA increases; when EVA falls, their incentive compensation should be at risk. This approach effectively makes a manager think like an owner, and provides strong motivation to make decisions that focus on the continuous improvement in EVA decisions that the market will reward.

A Commitment to Continuous Improvement A final condition for maximizing wealth is to focus on continuous improvement rather than short-term goals. Investors don't reward companies because managers have met their annual budget; they reward companies when managers regularly seek out and undertake initiatives that improve long-term performance. Stern Stewart encourages clients to stay focused on continuous improvement.

Value Based Strategy and Management

Stern Stewart's mission is to help clients establish clear, accountable links between management action and the creation of shareholder wealth. In our view, the most effective way to align management initiatives with shareholder interests is to implement a framework for decisionmaking that is based on our proprietary EVA measure. EVA has gained broad acceptance in the business community for its ability to help managers increase the value of their companies. More than 400 major corporations, globally, have adopted our EVA framework and been rewarded with significant improvements in corporate performance and share price.

3.4 RATIONALE FOR USING EVA

EVA is the gain or loss that remains after assessing a charge for the cost of all types of capital employed. What an accountant calls profits in an income statement includes a charge for the debt capital employed which is commonly referred to as interest expense. However, an income statement does not include a charge for the equity capital that was employed during the accounting period. Therefore, EVA goes beyond conventional accounting standards by including a provision for the cost of equity capital. The cost of equity needs to be factored into business investment decisions in order to enhance shareholder value. Although EVA is couched in financial analysis, its primary purpose is to shape management behavior. EVA can be used as a performance measure to evaluate an overall company, a division within a company, a location within a division, or an individual manager. By setting goals, EVA can become a motivational tool at various levels of management. EVA can also be used in downsizing decisions. Perhaps the real key to appreciating EVA lies in its simplicity.

4.0 OBJECTIVES AND SCOPE OF THE STUDY 4.1 OBJECTIVE OF THE STUDY The objectives of the study are:

1. To study the growth of power sector of the country in the following dimensions Annual per Capita consumption of Electricity (in kWh) in FY05 to FY10 Installed capacity in India since the Sixth Five Year Plan. Power generation in India FY01 to FY10 Power demand-supply in India in FY01 to FY10 2. To estimate the EVA of 6 Indian Power companies. They are : DPSC Ltd. NTPC Ltd. NHPC Ltd. Reliance Power Ltd. Tata Power Ltd. Torrent Power Ltd. 3. To determine how EVA is a tool to measure financial health of a company.
10 Strategies for increasing EVA

Increase the return on existing projects (improve operating performance) Invest in new projects that have a return greater than the cost of capital Use less capital to achieve the same return Reduce the cost of capital Liquidate capital or curtail further investment in sub-standard operations where inadequate returns are being earned

4.2 SCOPE OF THE STUDY

This project is carried on to study the overall development of the Indian power sector and the impact of EVA on financial health of a company. The scope of the study extends into the following areas. To find out the relationship between EVA and Profitability of the companies. To find out the MVA(Market Value Added) of the companies.

5.0 RESEARCH METHODOLOGY

5.1 STUDY TYPE: The study type is analytical, quantitative and historical. Analytical as facts and existing information is used for the analysis. Quantitative as EVA is calculated and the variables are expressed in measurable terms. Historical as the historical information is used for analysis and interpretation.

5.2 SAMPLE TECHNIQUE: The Sampling method used here is Non-Probability Sampling. Companies listed in the stock exchange are considered for the sample because market prices and other information are available. Since NIFTY is a good proxy for the whole market, so companies will be selected from the NIFTY Index.

5.3 SAMPLE SIZE: Sample includes 6 companies in the NIFTY (for which relevant data was available), for a period of 6 years starting from FY 2004-05 to FY 2009-10. The following are the sample 6 companies:

5.4 DATA COLLECTION:

5.4.0 Data type: Secondary data

5.4.1 Data Content: Historical share prices of the sample companies. Index values of S&P CNX 500. Financial Information of the sample companies.

5.4.2 Data Source: Historical share prices of the sample companies and the index points for the period has been taken from the database of Capital Market Publishers (India) Ltd., Capitaline 2000 as well as

from nseindia.com. Financial statements of the sample companies have also been taken from the same source.

6.0 ANALYSIS AND INTERPRETATION 6.1 GROWTH IN ANNUAL PER CAPITA CONSUMPTION OF ELECTRICITY (IN KWH) IN FY05 TO FY10

[ INSERT TABLE 6.1 ] INTERPRETATION : In India, annual per capita consumption of electricity in the country increased from 612.5 Kwh in FY01 to 762.2 Kwh in FY10 at a 6-year growth rate of about 3.3%. The increase in consumption from FY07 to FY08 is very low i.e 2%. The increase in consumption from FY06 to FY07 is very high i.e 6.3%. 6.2 GROWTH IN INSTALLED CAPACITY IN INDIA SINCE THE SIXTH FIVE YEAR PLAN. [ INSERT TABLE 6.2] INTERPRETATION : As on Mar 31 2010, Indias total installed generation capacity was 159,398.49 MW: 102,453.98 MW thermal, 36,863.4 MW hydro, 4,560 MW nuclear, and 15,521.11 MW of renewable energy sources (RES). State utilities contributed the maximum to Indias power generation followed by central and private sector utilities. Power generation capacity was highest in the western region followed by southern, northern, eastern, and north eastern regions. 6.3 GROWTH IN POWER GENERATION IN INDIA FY01 TO FY10

[ INSERT GRAPH 6.3] INTERPRETATION : In India, generation of electricity mainly comprises hydro, thermal, nuclear, and RES. Total electricity generated in the country increased from 499.5 BU in FY01 to 771.2 BU in FY10 at a 9-year CAGR of 4.94%. Thermal power plants are the highest generator followed by hydro and

nuclear power plants. In FY10, the western region was in the lead generating 249,307.99 MU, followed by the northern region with 215,061.72 MU. 6.4 GROWTH IN POWER DEMAND-SUPPLY IN INDIA IN FY01 TO FY10

[ INSERT GRAPH 6.4] INTERPRETATION : Considering the rising demand for power, there is an urgent need to improve power generation and distribution. The countrys challenge is to bridge the gap between demand and supply using the limited financial resources. Thus, the country needs to ensure optimum utilisation of existing installed capacity. The most cost-effective option of maximising generation is through renovation and modernisation of existing power plants. 6.5 CALCULATION OF EVA CALCULATION OF NOPAT, WACC, CAPITAL EMPLOYED NOPAT = EBIT (1-T) T = Normalise Tax Rate = 33% 6.5.0 CALCULATION OF NOPAT [ INSERT TABLE 6.5.0] [ INSERT GRAPH 6.5.0] INTERPRETATION : NOPAT is increased consistently and improved from year to year of almost all companies. There is some variations in case of Reliance Power Ltd. In 2007 and 2008, NOPAT of DPSC Ltd. has dropped, but in year 2009 it has improved a lot.

6.5.1 CALCULATION OF WACC FORMULA

WACC = D/V(1-T)Kd + (E/V)Ke Calculation of ke FORMULA Ke = Rf+BETA(Rm-RF) [ INSERT TABLE 6.5.1] [ INSERT TABLE 6.5.1] 6.5.2 ANALYSIS OF BETA [ INSERT TABLE 6.5.2] [ INSERT GRAPH 6.5.2] INTERPRETATION : It can be seen that beta for most of the companies has increased from year to year. Earlier, in 2005 to 2006 it was in range between 0.30 to 0.80 for NHPC Ltd. But slowly it has decreased and become negative by the end of 2010. Thus we can say that riskiness of the stock is increased during the period of 2005 to 2007 but then decreased during the period of 2008 to 2010 except in some cases.

6.5.3 CALCULATION OF Ke [ INSERT TABLE 6.5.3] 6.5.4 CALCULATION OF Kd Cost of Debt(kd)=i(1-T) i=8.5%,T=35% 0.05525

6.5.5 ANALYSIS OF WACC

[ INSERT TABLE 6.5.5] [ INSERT GRAPH 6.5.5] INTERPRETATION : From the table it is concluded that weightage average cost of capital (WACC) of the all companies during 2005 and 2010 has increased except in some cases. WACC is around 1-7 during these years. But in 2007 WACC is increased drastically because of increasing beta and market return as well as. In case of Reliance Power Ltd. and DPSC Ltd., WACC is very low because of negative beta.

6.6 CALCULATION OF CAPITAL EMPLOYED FORMULA Capital employed = Total equity shares + Total debt [ INSERT TABLE 6.6] [ INSERT GRAPH 6.6] 6.7 CALCULATION OF EVA FORMULA EVA= NOPAT (WACC x Capital employed)

6.7.0 ANALYSIS OF EVA [ INSERT TABLE 6.7.0] [ INSERT GRAPH 6.7.0] INTERPRETATION : It can be understood from graph that there is no consistent pattern of economic value created by the selected companies. Sometimes, it is negative and some time it is positive. In year 2008 and

2009, Economic Value added of all the companies is negative only NHPC Ltd. has positive EVA. EVA of the most companies is increased in comparison of previous year except Reliance Power Ltd. and Torrent Power Ltd. EVA of these four companies is decreased compare to previous year. While, EVA of NHPC Ltd. and DPSC Ltd. is positive. In year 2006, economic value added is again combination of positive and negative like in year 2004. The companies, those created value to shareholders are NHPC Ltd., NTPC Ltd., DPSC Ltd., Tata Power Ltd and Torrent Power Ltd. Except these companies no other companies added any economic value.

7.0 FINDINGS AND RECOMMENDATIONS 7.1 FINDINGS Growth of power sector is increasing year by year. WACC of all the companies are increasing year by year. Beta value has greater impact on company return. EVA of most of the companies are negative. That means very few companies are increasing their shareholders value year by year. They are : NHPC Ltd. and DPSC Ltd. 7.2 RECOMMENDATIONS Economic Value Added is a residual income variable. It is defined as Net operating profit after taxes subtracted with the cost of capital tied in operations. EVA seems to have importance for companies as a performance measurement and controlling tool. First of all it is fairly simple measure but still measures well the ultimate aim of any given company, the increase or decrease in shareholders wealth. Maximizing traditional performance measures like ROI is not theoretically in line with maximizing the wealth of shareholders. Therefore EVA is superior to conventional performance measures. The premise behind EVA that businesses must cover their capital costs is neither new nor peculiar. Putting it into practice can still be eye-opening. EVA shows financial performance with a new pair of glasses or offers new approach especially for the companies where equity is viewed as free source of funds and performance is measured by some earnings figure. At best EVA helps with creating a mind-set throughout the organization that encourages managers and employees to think and behave like owners. Substantial shareholder value increases and true success stories arise always from outstanding strategy, quick response, great ideas and good predicting of future. EVA helps in quantitative assessing of different strategies but that is all. Wealth does not arise from EVA alone. EVA only measures changes of wealth. It is also as short-term as all other periodic performance measures. Therefore all companies should rely also on other performance measures. Especially important this is e.g. for new growth phase companies. However we have to bear in mind that the success or failure of any given company is measured ultimately as created shareholder value. Therefore EVA is

important measure also for those companies that use primarily other tools is assessing the achievement of their strategic goals

8.0 LIMITATIONS OF THE STUDY Power sector is a large sector of India. It has lots of companies. Since this study is limited to fifteen days it is not possible to carry out the study in further details. The study is restricted to define the relationship between EVA and shareholders wealth. Here data are collected mainly from annual reports, publicized reports and company websites only.

9.0 CONCLUSION The above discussion explains the importance of using EVA as a tool for measuring financial performance. The study reveals that there is no strong pattern of EVA of selected companies during the period. The wealth created by most companies in year 2004 and 2006 is negative because of higher cost of capital than that of other years. The central idea of EVA is subtracting the cost of capital from the firm's profits to measure, as the term indicates, the economic additional value produced by the firm to its owners over the weighted cost of the capital employed. This raised the question of the effect of the debt and equity cost components on the behavior of EVA. It was observed that the cost of debt has little effect on the EVA's. On the other hand, as is expected, EVA behaves in a linear fashion with respect to the cost of equity. It was also observed that even EVA is much more unstable than the other performance measure. It is also observed that there is no strong relation between EVA and market prices of the companies. Thus, it can be understood that investor do not give so importance to EVA for its investment decision. Extensive study is required to establish the influence of other factors like non-fund based income, spread, deployment of funds, market price, etc. It is also expected that the usage of EVA as a financial performance tool will also be more in India.

10.0 REFERENCE Magazines Annual report of all the companies (2004-05 to 2009-10) The Analyst (magazine published by CFA) Newspapers The Hindu Business Standard Websites www.nseindia.com www.rbi.org.in www.capitaline.com www.investopedia.com http://industrytracker.wordpress.com/2010/08/27/power-sector-in-india-statistics/ http://www.dnb.co.in/InfrastructureCompanies2009/Power%20Sector.asp

ANNEXTURE 2.1.0.1 FIGURE OF REGION WISE AND SECTOR WISE INSTALLED CAPACITY (As on Mar 31, 2010)

6.1 GROWTH IN ANNUAL PER CAPITA CONSUMPTION OF ELECTRICITY (IN KWH) IN FY05 TO FY10 TABLE WITH GRAPH

All India Annual {Per Capita consumption of Electricity (in kWh) 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 612.50 631.50 671.89 717.13 733.54 762.20
1000 800 600 400 200 0 2004-05

ANNUAL PER CAPITA CONSUMPTION

2005-06

2006-07

2007-08

2008-09

2009-10

6.2 GROWTH IN INSTALLED CAPACITY IN INDIA SINCE THE SIXTH FIVE YEAR PLAN. TABLE

6.3 GROWTH IN POWER GENERATION IN INDIA FY01 TO FY10 GRAPH

6.4 GROWTH OF DEMAND AND SUPPLY IN INDIA IN FY01-FY10 GRAPH

CALCULATION OF EVA CALCULATION OF NOPAT, WACC, CAPITAL EMPLOYED 6.5 TABLE OF EBIT Company Name D P S C Ltd. N H P C Ltd. N T P C Ltd. Reliance Power Ltd. Tata Power Co. Ltd. Torrent Power Ltd. EBIT 6.49 1243.82 7821.8 -0.01 897.38 0 EBIT 11.16 1279.49 8387.8 -0.11 904.84 440.8 EBIT 10.04 1581.79 10248.3 0.54 965.91 201.23 EBIT 9.07 1789.89 11686.5 100.87 1238.34 583.32 EBIT 16.29 1976.74 12987.2 256.47 1555.38 634.76 EBIT 18.58 3375.41 13950.6 288.94 1701.33 1496.5

6.5.1 TABLE OF NOPAT Company Name D P S C Ltd. N H P C Ltd. N T P C Ltd. Reliance Power Ltd. Tata Power Co. Ltd. Torrent Power Ltd. 2004-05 4.3483 2005-06 7.4772 2006-07 6.7268 2007-08 6.0769 2008-09 10.9143 2009-10 12.4486

833.3594 857.2583 1059.799 1199.226 1324.416 2261.525 5240.606 5619.826 6866.361 7829.955 8701.424 9346.902 -0.0067 -0.0737 0.3618 67.5829 171.8349 193.5898

601.2446 606.2428 647.1597 829.6878 1042.105 1139.891 0 295.336 134.8241 390.8244 425.2892 1002.655

6.5.1 GRAPH

NOPAT
10000 8000 6000 4000 2000 0 2004-05 -2000 2005-06 2006-07 2007-08 2008-09 2009-10 D P S C Ltd. N H P C Ltd. N T P C Ltd. Reliance Power Ltd. Tata Power Co. Ltd. Torrent Power Ltd.

6.5.2 TABLE OF BETA Company Name DPSC Ltd 2005-06 BETA 0.0000118 2006-07 -0.00004563 2007-08 0.0000275 2008-09 -8.3206 NHPC Ltd NTPC Ltd RELIANCE Power TATA POWER Torrent Power BETA -0.0000654 BETA 1.1605 BETA 0.00003762 -0.0000632 -4.4205 1.3305 -0.000111 -1.0405 -5.6605 -5.7005 -7.2406 -8.8005 -1.7604 -1.9505 -3.1605 BETA 0.0000325 BETA 4.2505 0.0000893 0.000114815 -0.0000129 -7.0905 0.0000367 -6.4205 -5.3405 -2.9504 2009-10 -1.5805

6.5.2 GRAPH

BETA
0.0002 0.0001 0 2004-05 -0.0001 -0.0002 -0.0003 -0.0004 2005-06 2006-07 2007-08 2008-09 2009-10 DPSC Ltd NHPC Ltd NTPC Ltd RELIANCE Power TATA POWER Torrent Power

6.5.3 TABLE OF RF 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 RF RF RF RF RF RF 6.45885 7.3785 8.0612 7.6489 7.8529 7.2367

6.5.3 TABLE OF MARKET RETURN 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 RM RM RM RM RM RM 0.000548 0.002047 0.000466 0.000853 -0.00185 0.00177

6.5.3 TABLE OF COST OF EQUITY (Ke) Company Name 2004-05 DPSC Ltd NHPC Ltd NTPC Ltd RELIANCE Power TATA POWER Torrent Power 7.648966538 6.4600 7.236796442 7.37898242 8.061709438 7.6497487 7.3800 8.0600 7.6500 7.6500 7.8500 7.8500 7.8500 7.2400 7.2400 7.2400 6.458630418 7.37787669 6.460494639 2005-06 2006-07 2007-08 2008-09 2009-10 7.2400

7.37841294 8.061104883 7.64868968 7.8500

7.37826027 8.060480176 7.64899866 7.85318827 7.2400 7.3800 8.060274507 7.6500 7.8500 7.2400

7.23642782 8.0600

6.5.5 TABLE OF WACC WACC Company Name DPSC Ltd NHPC Ltd NTPC Ltd RELIANCE Power TATA POWER Torrent Power 0.035913 4.51 0.03567 0.035913 5.72 4.452 0.035913 6.24 3.67845 4.972337 5.38 7.10045 5.1 4.46 7.008947 5.7 5.81 7.004393 2004-05 0.035913 0.035913 5.197892 2005-06 0.035913 0.035913 6.05 2006-07 0.035913 0.035913 6.609225 2007-08 7.352651 0.035913 6.57 2008-09 7.14 0.035913 6.34 2009-10 6.008911 6.37 6.95

6.5.5 GRAPH

WACC
8 7 6 5 4 3 2 1 0 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 DPSC Ltd NHPC Ltd NTPC Ltd RELIANCE Power TATA POWER

6.6. TABLE AVERAGE CAPITAL EMPLOYED Annual Rs. Crore Dec-05 Average COMPANY NAME D P S C Ltd. N H P C Ltd. N T P C Ltd. Reliance Power Ltd. Tata Power 7346.94 8114.25 8711.57 10073.58 12045.69 14765.45 0.04 -0.03 99.98 6871.36 13667.74 13929.43 Capital employed 76.9 20544.99 55370.95 Annual Rs. Crore Dec-06 Average Capital employed 75.69 21775.25 62399.15 Annual Rs. Crore Dec-07 Average Capital employed 83.37 23254.18 69667.35 Annual Rs. Crore Dec-08 Average Capital employed 93.67 25656.65 77470.25 Annual Rs. Crore Dec-09 Average Capital employed 102.37 28322.69 87842.1 Annual Rs. Crore Dec-10 Average Capital employed 110.24 33276.87 98153.4

Co. Ltd. Torrent Power Ltd.

NA

1627.59

3736.74

4820.98

5954.68

6818.57

6.6 GRAPH

AVERAGE CAPITAL EMPLOYED

150000 100000 50000 0 -50000 D P S C Ltd. 76.9 N H P C Ltd. 20544.99 N T P C Ltd. 55370.95 Reliance Power Ltd. 0.04

6.7.0 TABLE OF EVA EVA Company Name DPSC Ltd NHPC Ltd NTPC Ltd RELIANCE Power TATA POWER Torrent Power -0.00814 -32533.5 0 -0.07262 -45807.3 -6950.69 -3.22873 -53713 -13610.6 -34099.1 -53366.2 -33840.3 -69533.6 -52681.7 -41310.7 -65274.7 -84647.4 972.7037 2004-05 1.586629 95.53745 -282572 2005-06 4.758983 75.25463 -371895 2006-07 3.732775 224.6833 -453581 2007-08 -682.646 277.8316 -501150 2008-09 -720.008 307.2774 -548217 2009-10 11.46628 -176435 -574666

6.7.0 GRAPH

EVA
100000 0 -100000 -200000 -300000 -400000 -500000 -600000 -700000 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 DPSC Ltd NHPC Ltd NTPC Ltd RELIANCE Power TATA POWER Torrent Power