A Project on

“Economic Value Added”

In
Kirloskar Oil Engines Ltd.

RUTIKA KALE.
MBA-07003059
 Executive Summary
 Name of the Company:
Kirloskar Oil Engines Ltd. Pune.
 Project title : “Economic Value Added”
 Scope of study :
Study focuses on calculation of Economic Value
Added (2003-2007) and encompasses on capital
structure and cost of capital.
 Period of study :
Secondary financial data of 5 years ( 2003- 2007) is
used to measure EVA
 Continued…
• Tools for data analysis:
1. Formula of EVA is used to analyze EVA.
2. M. S. Excel.

 Research Methodology:
1. Annual Reports
2. Company Website

 Objectives of the study:

1. To measure the Economic Value Added (EVA) of the
organization.
2. To suggest strategic path for improvement of EVA
 Profile of Kirloskar Oil Engines Ltd
 Kirloskar Oil Engines (KOEL) was incorporated in 1946 .
 Its manufacturing units are at Ahmednagar, Nasik, Pune, &
Kagal in Maharashtra.
 KOEL manufactures diesel engines in the 3-hp to 7,200-hp
range commanding roughly 17% market share. Its products
range includes diesel engines, irrigation pump sets, diesel
generating sets, engine bearings and valves and gray iron
castings.
 KOEL is Awarded as ISO 9001 certification since 1992 .
 Golden Peacock, 1997 and 2003- Highest national Award for
Design Innovation QS 9000 certification for engine bearings
since 1998 .
 Introduction to “Economic Value Added”
 Economic Value Added (EVA), originally proposed by
the firm of consultants named, Stern Stewart & Co. the
Fortune magazine has called it as “today’s hottest financial
idea and getting hotter”.

 EVA is a measurement tool designed to strengthen

companies’ return on capital investments.

 EVA is the key to creating corporate wealth.

 Continued…

 EVA is essentially the surplus left after making an

appropriate charge for the capital employed in the Business.

 EVA is quite popular in measuring performance because it

has some powerful impacts on organizational behavior.

 Any profit earned over and above cost of capital is Economic

Value added or excess of profit of a firm after charging cost
of capital.

 EVA is a measure that enables managers to see whether they

are earning an adequate return .
 Components of EVA

 Net Operating Profit After Tax (NOPAT) :

NOPAT = (Profit Before Interest And Tax) (1 – Tax Rate)
 Cost of Capital:
 Capital Employed:

The formula of EVA is:

EVA = NOPAT – Cost of Capital * Capital
 Analysis & Findings
 Calculation of Net Operating Profit After Tax (NOPAT) (Rs in Mil)

Particulars 2006-07 2005-06 2004-05 2003-04

Profit after tax (PAT) 1784.09 2005.87 1738.95 756.00

*Interest post tax 28.92 24.65 11.38 15.49

Less: Profit on sale of 190.90 974.94 1133.2

investments
Less: Profit on sale of 33.29
undertakings
Net Profit after 1588.82 1055.58 617.15 771.49
depreciation& taxes
but before interest
cost (NOPAT)
 Chart Showing growth of NOPAT

1600 1588.82

1400
1200
1055.58
1000
Net Profit after
800 771.49 depreciation& taxes
617.15 but before interest
600
cost (NOPAT)
400
200
0
2006-07 2005-06 2004-05 2003-04
 Calculation of Average Capital
Employed

Particulars 2007-06 2006-05 2005-04 2003-04

*Average 7892.92 5348.19 3795.63 3953.75
Equity

* Average Debt 770.26 586.93 324.11 363.73

Average 8663.18 5935.12 4119.74 4317.48

Capital
Employed
Chart showing Growth of Capital Employed

9000 8663.18
8000
7000
5935.12
6000
5000 4317.48
4119.74 Average Capital
4000
Employed
3000
2000
1000
0
2007-06 2006-05 2005-04 2003-04
 Calculations of cost of equity
Particulars Years

2007-06 2006-05 2005-04 2003-04

a) *Risk free return equivalent to yield on 8.00% 7.10% 6.08% 5.50%

long term (10yr) Govt. Bonds

b) *Shareholders expectation of optimum 15.24% 15.00% 12% 11%

return.

c) Market Risk Premium Difference (b-a) 7.24% 7.90% 5.50% 5.50%

d) *Beta variant for company's risk vis -a 0.84 0.70 0.22 1.2
vis market risk.
e) Adjusted market risk premium for 6.05% 5.53% 1.20% 6.60%
company (c*d)

Cost of Capital (a+e) 14.05% 12.63% 7.28% 12.10%

 Calculations of Cost of Debt
Particulars Years

2007-06 2006-05 2005-04 2003-04

1.*Interest paid 43.81 37.13 17.94 24.15

1.*Average Debt 770.26 586.93 324.11 363.75

c) Cost of Debt %(a/b) 5.69% 6.33% 5.54% 6.64%

d) Tax rate 33.99% 33.66% 36.59% 35.88%
e) Cost of Debt( Post Tax) 3.75% 4.20% 3.51% 4.26%
(c x (1-d))

Cost of Debt 28.92 24.65 11.38 15.49

 Calculation of Weighted Average Cost of
Capital and Economic Value Added
Particulars 2007-06 2006-05 2005-04 2003-04
WACC (Post tax)

a) Equity 7892.92 5348.19 3795.63 3953.75

Cost % 14.05% 12.63% 7.28% 12.10%
A) Cost of Equity 1109.03 675.48 276.32 478.40
(Rs)
b) Debt 770.26 586.93 324.11 363.75
Cost % 3.75% 4.20% 3.51% 4.26%
B) Cost of Debt (Rs) 28.92 24.65 11.38 15.50
C) WACC (A + B) 1137.95 700.13 287.70 493.89
D) WACC % 13.14% 11.80 6.98 11.44
[C/(a+b)]
E) EVA=NOPAT - 450.87 355.45 329.45 277.60
WACC [C]
 Chart showing growth of EVA

500
450 450.87
400
355.45
350 329.45
300 277.6
250 E) EVA=NOPAT -
200 WACC [C]
150
100
50
0
2007-06 2006-05 2005-04 2003-04
 Findings
 There is a sharp increase in the WACC due to larger
component of equity as compared to debt. While cost of
Equity is 14.05%, the cost of Debt for KOEL is only 3.75%.

 As the average debt component is small, this results in a

higher average cost of capital of 13.14%.

 During the year, the Company generated NOPAT of Rs.

1588.82Millions, as against Cost of Capital of Rs. 1137.95
Millions. The EVA for the year was positive to the extent of
Rs. 450.87 Millions.
 Continued…

 The EVA has increased to 227.60 (Rs in mil) in the

year 2003-04 compared to its previous year 2003-02
which is because the increase in the NOPAT to 772
(Rs in Mil) of 2003-04 & with a lower cost of capital
i.e 12.10%.

 In the year 2006-07 there is increase in EVA to Rs

450.87 (in mil) compared to previous year 2004, 2005
this is because of the increase in NOPAT
 Suggestions
 If the company can improve it’s EVA by increasing its NOPAT
which could be increased by increase in sales and reducing the Cost
of Capital .

 The company can still increase its Economic Value Added (EVA) by
reducing the Cost of Capital. The Cost of Capital can be reduced by
withdrawal of unproductive investment.

 Increase in EVA can attract FDI.

 EVA can also be used as a measurement tool for measuring the

performance of management.
 Bibliography
 http:/www.evanomics.com
 http:/www.EVA.com
 http:/www.valuebasedmanagement.net
 http:/www. Stern Stewart & Co. com
 http:/www.BusinessFinanceMag.com, Capitalizing on EVA
by Tad Leahy, page 1-4.
 Financial Management, by Prassana Chandra.
 Management of Cost, Finance & Human Resource for Good
Governance by Dr. D.N.S.Kumar.
 Accounting Standards & Corporate Accounting Practices by
T.P.Ghosh
 Company Magazines, journals & Company Websites.