Abstract

The performance of a company in financial terms is measured in many traditional measures.

These measures include Net Profit Margin, Operating Profit Margin, Return on Investment
(ROI), Return on Net Worth (RONW), Earning Per Share (EPS) etc. Among these, ROI is
recognized as the most popular yardstick of overall performance. But it is often argued that, in
general, these traditional measures fail to identify the true surplus. Various analysts have given
different reasons behind this. Economic Value Added (EVA) is advocated as a new measure of
corporate performance that focuses on clear surplus in contrast to the traditionally used profit
based indicators. EVA is based on the concept that a successful firm should earn at least its cost
of capital. Firms that earn higher returns than financing costs benefit shareholders and account
for increased shareholder value. For evaluation of the efficiency of any decision, value creation
or value addition aspect is of utmost importance in the present backdrop of corporate
governance. Although adopting a holistic approach safeguarding the interests of all stakeholders
is being emphasized and rightly so, it should be kept in mind that value creation or value addition
aspect is of prime consideration in the assessment of the corporate policy guidelines. If that is not
satisfied, wrong signals will be emitted from securities market and the continuance of the
operations of the entity will be at stake. In view of the above considerations, in the present paper
an attempt has been made to analyze the financial performance of three automobile companies of
India by using EVA.
Introduction

EVA® (Economic Value Added) was developed by a New York Consulting firm, Stern Steward &
Co in 1982 to promote value-maximizing behavior in corporate managers. This term has been
used in the book named “The Quest for Value” which was published in 1991. Stern Steward &
Co claims EVA to be their registered trade mark, while Peter Drucker claimed that he discussed
EVA in 1964 in his book, “Managing for Results”. It cannot be denied; however, without going
into argument as to who invented EVA first that the concept became popular only after Stern
Stewart & Co. marketed it.
EVA is a value-based measure that was intended to evaluate business strategies, capital projects
and to maximize long-term shareholders wealth. Value that has been created or destroyed by the
firm during the period can be measured by comparing profits with the cost of capital used to
produce them. The detailed analysis using EVA may enable the managers to find out activities
which are less profitable, and where the profits are being ‘eaten-up'. EVA, therefore enables the
management to, invest in projects that are critical to shareholder's wealth. This will lead to an
increase in the market value of the company. However, activities that do not increase
shareholders value might be critical to customer's satisfaction or social responsibility. For
example, acquiring expensive technology to ensure that the environment is not polluted might
not be of high value from a shareholder's perspective. Focusing solely on shareholder's wealth
might jeopardize a firm reputation and profitability in the long run.
Researchers have found that managers are more likely to respond to EVA incentives when
making financial, operational and investing decision (Biddle, Gary, Managerial finance 1998),
allowing them to be motivated to behave like owners. However this behavior might lead to some
managers pursuing their own goal and shareholder value at the expense of customer satisfaction.
Unlike traditional methods of performance measurement, EVA focuses on ends and not means. In
other words, we can say that it does not state how manager can increase company's value as long
as the shareholders wealth is maximized.
If we talk about the corporate houses, Cola-Cola is one of the many companies that adopted EVA
for measuring its performance. Its aim, which was to create shareholders wealth, was announced
in its annual report. The EVA calculation show that Coca-Cola's investor received $8.63 wealth
for every dollar they invested.
Mathematically, the EVA can be calculated as

EVA = (NOPAT – WACC) X Capital Employed

Where,
NOPAT means Net Operating Profit before Interest and after Tax
WACC represents Weighted Average Cost of Capital.
Objective:
To study the operational efficiency of the company through the EVA analysis and to understand
how EVA is a useful tool for analysis of a company’s performance.

Literature Review

Baatz (1994) commented that it is but one of many tools being developed to account for the
capital invested in an organization by the true owners of that organization - the shareholders.

Dodd and Chen (1996) explain that EVA is the difference between companies adjusted net
operating profit (after taxes) in a particular year and it total cost of capital.

Rice (1996) indicates there is a growing movement that believes EVA is a tool which can, and
should, be used on an organization-wide basis – particularly in decisions related to the cost
justification of capital equipment. More specifically, we are interested in this paper in how one
organization has used EVA in the capital equipment cost justification process of Advanced
Manufacturing Technology (AMT).

Gompers et al. (2003)examine the relationship between corporate governance and long-term
equity returns, firm value and accounting measures of performance. Their results reveal that
well-governed firms have higher equity returns, command higher values and their accounting
statements show a better operating performance compared to their poorly governed counterparts.
Corporate Governance has a key role to play in the company performance. Investors are
encouraged to consider corporate governance in their investment decisions.
Ali El Mir and Souad Seboui (2008) state that basically the gap created between the
Shareholders’ value and EVA could be better explained by Corporate Governance mechanism.
George Athanassakos (2007) finds that the Value-based management (VBM) is a management
philosophy that uses analytical tools and processes to focus an organization on the single
objective of creating shareholder value. It includes an alignment of corporate strategy,
performance reporting and incentive compensation, and aids to bring all staff together to act like
shareholders, making decisions that maximize value. These decisions should ultimately lead to
improvements in stock market performance over the long run. A good measure of value-based
management is Economic Value added (Value-based management, EVA and stock price
performance.

Lloyd M. Austin (2005), citing ACNZ case adopted EVA as a benchmark to manage firm’s value
and to control its pricing policy. Though, the most accepted valuation methodologies use the Net
Present Value (NPV). But there was no regulation that provides a mandatory calculation method
for the firm’s performance in financial terms. Finally, ACNZ was able to show via the EVA
approach that it was not a monopoly and it was successful in evading price control measure.

Lehn and Makhija (1996:36) conducted a study to find out how well EVA and MVA relate to
share price performance and to see whether Chief Executive Officer (CEO) turnover (the number
of new CEOs during a given period) is related to EVA and MVA. EVA, MVA and CEO turnover
revealed that the CEOs of companies with high EVAs and MVAs had much lower rates of
dismissal than CEOs responsible for low EVAs and MVAs. As expected, a strong inverse
relationship was found between share prices and CEO turnover. The CEO turnover rate for
companies with share returns above the median was EVA and MVA are effective performance
measures that contain information about the quality of strategic decisions and that serve as
signals of strategic change.

Biddle, Bowen and Wallace (1997) say that EVA is more closely associated with equity returns or
firm values than is net income. Two empirical researches were made regarding this. The first
research considers claims regarding the purported superiority of EVA in explaining stock returns
and firm values. The second examines whether managers appear to respond to EVA incentives
when making operating, investing and financing decisions. The work finally establishes that the
comparison between EVA and Earnings according to “Does EVA beat earnings? Evidence on
associations with stock returns and firm values” is not correct and the EVA does not represent actual
profit picture of the firm.

Ahmad Ismail (2006) advocates that after regression analysis of stock return and measures such
as EVA, RI, NI, NOPAT using data from UK companies, came to a conclusion that NI and
NOPAT outperform EVA. EVA model is not able to capture more than 20-24 percent of the
variation in stock return. This leaves 76-80 percent of the variation unexplained. He finally
concludes that there are other non-earnings and non-EVA factors that drive share value and these
should be taken into account either for shareholders’ value.

Research Questions:
1) To compare traditional measures ROE, EPS and ROI with EVA & and find ‘whether ROI
and ROE really reflect the value added to shareholders Capital’?
2) For a Company, what does a positive or negative EVA signify, and what does it mean if
the EVA changes sign in a span of years.

Methodology:
Three companies (one each from Small, medium and large size with respect to their turnovers in
the automobile sector) have been selected. A comparative study has be done wherein different
financial ratios like leverage ratios, liquidity ratios and cost coverage ratios and others has been
be calculated and interpreted. To evaluate the return on this invested capital, we need an estimate
of the after-tax operating income earned by a firm on these investments. Again, the accounting
measure of operating income has to be adjusted for operating leases, R&D expenses and one-
time charges to compute the return on capital.
Then, EVA has been calculated using the formula:
Economic Value Added = NOPAT – (WACC x CAPITAL EMPLOYED).
NOPAT is calculated as equal to adjusted EBIT(1-T).
ROI = PAT
CAPITAL EMPLOYED
ROE is calculated using Du Pont analysis:
ROE= PAT x Net Sales x Total Asset
Net Sales x Total Asset x Equity

After the calculations, the results thus obtained from the other methods of measurements had
been compared with the EVA analysis of the same companies.
We have calculated the production and other significant expenses as the percentage of net sales.
These values have been used to understand the impact of various expenses on the EVA for the
company.
Data type and years of data:
Data from secondary sources like Prowess and Money control.com have beenused. Financial
ratios have beencalculated using the financial statements procured form the annual reports of the
company. Annual reports of past five years (2004-2008) have been used to consolidate our
study. Some data has been retrieved from BSE websites.
3. Comparisons and Findings

EVA as % of capital employed

Year M&M TATA EICH SWARAJ
LTD. MOTORS ER MAZDA.
2 9.74 -13.94 14.6 49.81
004 6
2 14.29 -11.41 17.2 34.97
005 5
2 13.13 12.27 -0.19 8.72
006
2 15.44 15.34 6.98 9.75
007
2 10.09 14.34 5.82 20.01
008
EXIBIT 1

ROI
Year M & M TATA EICH SWARAJ
LTD. MOTORS ER MAZDA.
2 33.25 7.67 9.10 43.98
004
2 42.56 8.47 16.5 31.10
005 7
2 42.84 11.41 35.6 9.61
006 2
2 39.52 12.79 10.2 10.11
007 2
2 32.34 12.19 9.90 16.24
008
EXIBIT 2

ROE Calculated using: Du Pont

Analysis
Year M & M TATA EICH SWARAJ
 LTD. MOTORS ER MAZDA.
2 28.92 4.62 8.49 11.04
004
2 38.50 5.96 10.2 10.01
005 3
2 33.83 8.10 28.4 9.68
006 2
2 34.96 8.68 7.60 8.99
007
2 31.27 7.59 7.23 12.22
008
EXIBIT 3

Interpretation: TATA MOTORS

The EVA for the year 2004 and 2005 is negative i.e. (633.4) (690.02) which mean its earning
were less than the cost of capital. Also the trends for the ROI and ROE are justified by the
positive trend of EVA.
The EVA in the year 2006 I moving from the negative into a positive territory this is a good
buying signal (Ben McClure investment analyst, McClure & Co).

Interpretation: MAHINDRA &MAHINDRA LTD.

The values of the EVA for the consecutive years are decreasing this fluctuating trend indicate
inconsistency in operation efficiency. The EVA and ROE trend is positive but investing based on
the trend of ROI can mislead the investing decision. Further the trend of EVA is increasing but
the increase is less significant as in case of TATA MOTORS.
Hence if we compare TATA MOTORS and MAHINDRA &MAHINDRA Ltd. then the EVA
indicators suggest the TATA MOTORS is winner in terms that it adds economic values (EVA as
percentage of capital employed of TATA MOTORS and MAHINDRA &MAHINDRA Ltd are
10.03% and 14.33% respectively)

Interpretation: SWARAJ MAZDA

The EVA trend is negative, but when the figures from the year 2006 to 2008 is considered the
trend is positive in case EVA, ROI, ROE which mean its operational; efficiency is increasing

Interpretation: EICHER MOTORS

First when we look at the figures of ROI and ROE for the year 2006, there overwhelming returns
can mislead the investing decision, but the EVA here tell the true story for EICHER motors and
reports a negative figure of (1.71) Cr. The reason for the sudden increase in the returns was due
to the sale of Fixed assets by the company in that year for Rs 173 Cr and this is not taken into the
adjusted EDBIT for calculation of NOPAT for EVA calculation which indicated the true
economic value added by the company. Also the trend for EVA, ROI and ROE is negative which
indicate that the company is underperforming.
Hence when we compare SWARAJ MAZDA and EICHER MOTORS performance based on
EVA indicators (EVA as percentage of capital employed for SWARAJ MAZDA and EICHER
MOTORS was 20.01% and 5.81%)
 Eicher Vs Swaraj Mazda
Eicher Motors

2004 2005 2006 2007 2008

1995.7 1649.3 1968.6 2218.8
Net Sales 1372 7 8 4 3

1509.6 1279.8 1445.5 1672.0

Raw Materials 970.88 8 9 3 8
70.763 75.643 77.598 73.427 75.358
% 85 99 25 85 63
Power & Fuel
cost 15.07 17.56 13.19 14.86 15.88
1.0983 0.8798 0.7996 0.7548 0.7156
% 97 61 94 36 93
Employee Cost 90.18 104.5 93.36 103.09 128.47
6.5728 5.2360 5.6603 5.2366 5.7899
% 86 74 09 1 88
Selling &
Admin exp 158.93 206.47 210.11 258.17 296.4
11.583 10.345 12.738 13.114 13.358
% 82 38 73 13 39
PAT 33.62 58.85 216.88 61.26 63.05
2.4504 2.9487 13.149 3.1117 2.8415
% 37 37 18 93 88

Swaraj Mazda

2004 2005 2006 2007 2008

Net Sales 478.02 589.62 611.82 601.34 669.57

Raw Materials 371.56 480.85 522.35 506.17 565.55

77.728 81.552 85.376 84.173 84.464
% 97 53 42 68 66
Power & Fuel
cost 2.24 3.77 3.97 3.76 3.55
0.6393 0.6488 0.6252 0.5301
% 0.4686 95 84 7 91
Employee Cost 19.25 20.39 22.27 26.68 29.14
4.0270 3.4581 3.6399 4.4367 4.3520
% 28 59 59 58 47
Selling &
Admin exp 43.87 41.67 34.52 31.82 32.4
9.1774 7.0672 5.6421 5.2915 4.8389
% 4 64 82 16 26
PAT 21 24.25 16.78 16.09 25.2
4.3931 4.1128 2.7426 2.6756 3.7636
% 22 18 37 91 09
Tata Motors vs Mahindra Automotives

Tata Motors

2004 2005 2006 2007 2008

13028. 17199. 20088. 26664. 28738.
Net Sales 17 17 63 25 3

8578.1 12245. 14633. 19879. 20891.

Raw Materials 2 28 02 56 33
65.842 71.196 72.842 74.555 72.695
% 86 92 3 11 08
Power & Fuel
cost 214.52 237.81 258.51 327.41 325.19
1.6465 1.3826 1.2868 1.2278 1.1315
% 86 83 47 99 56
1039.3 1143.1 1367.8 1544.5
Employee Cost 882.49 4 3 3 7
6.7737 6.0429 5.6904 5.1298 5.3746
% 07 66 33 27 05
Selling & Admin 1061.0 1505.2 2197.4
exp 685.01 890.21 7 3 9
5.2579 5.1758 5.2819 5.6451 7.6465
% 14 89 43 24 55
1236.9 1528.8 1913.4 2028.9
PAT 810.34 5 8 6 2
6.2199 7.1919 7.6106 7.1761 7.0599
% 07 17 73 25 86

Mahindra & Mahindra

2004 2005 2006 2007 2008

4931.6 6594.6 8136.5 9921.3 11310.
Net Sales 7 9 9 4 37

3417.5 4829.2 5885.2 6937.1 7963.8

Raw Materials 2 9 1 6 2
69.297 73.229 72.330 69.921 70.411
% 42 98 18 6 67
 Power & Fuel
cost 45.64 52.64 57.46 65.19 91.33
0.9254 0.7982 0.7061 0.6570 0.8074
% 47 18 93 69 89
Employee Cost 417.45 464.25 551.78 666.15 853.65
8.4646 7.0397 6.7814 6.7143 7.5474
% 78 55 65 15 98
Selling & Admin 1108.3
exp 431.03 545.57 667.99 891.29 3
8.7400 8.2728 8.2097 8.9835 9.7992
% 41 68 05 65 37
1068.3 1103.3
PAT 348.54 512.67 857.1 9 7
7.0673 7.7739 10.533 10.768 9.7553
% 83 82 9 61 84

Application of EVA in the industry:

1) Make better investment decisions:
The management can use the EVA for accessing the performance of the business units or
segments within the company. If the segment is making surplus after achieving the cost of capital
then it makes sense to invest into it.
2) It helps in designing compensation system for managers based on EVA.
3) It brings goal congruence or matching of employees and shareholders It provides significant
information beyond traditional accounting measures like ROI, ROCE, EPS etc
Conclusion:
EVA is superior to conventional measures because it replicates the discipline of the capital
markets within the firm by explicitly measuring Return on Capital Employed (ROCE) relative to
the cost of equity.