MVA and EVA 355For most companies, the total amount of investor-supplied capital is the sum of equity,
debt, and preferred stock. We can calculate the total amount of investor-supplied
capital directly from their reported values in the financial statements. The total mar-
ket value of a company is the sum of the market values of common equity, debt, and
preferred stock. It is easy to find the market value of equity, since stock prices are read-
ily available, but it is not always easy to find the market value of debt. Hence, many an-
alysts use the value of debt that is reported in the financial statements, or the debt’s
book value, as an estimate of its market value.
For Coca-Cola, the total amount of reported debt was $6.9 billion, and Coca-Cola
had no preferred stock. Using this as an estimate of the market value of debt, Coke’s
total market value was $123.5 $6.9 $130.4 billion. The total amount of investor-
supplied funds was $10.4$6.9$17.3 billion. Using these total values ,the MVA
was $130.4 $17.3 $113.1 billion. Note that this is the same answer that we got us-
ing the previous definition of MVA. Both methods will give the same results if the
market value of debt is approximately equal to its book value.Economic Value Added (EVA)
Whereas MVA measures the effects of managerial actions since the very inception of a
company, Economic Value Added (EVA)focuses on managerial effectiveness in a
given year. The EVA basic formula is as follows:
EVA Net operating profit after taxes (NOPAT)
After-tax dollar cost of capital used to support operations (9-10)
EBIT(1 Corporate tax rate) (Operating capital)(WACC).
Operating capital is the sum of the interest-bearing debt, preferred stock, and com-
mon equity used to acquire the company’s net operating assets, that is, its net operat-
ing working capital plus net plant and equipment. Operating assets by definition
equals the capital used to buy operating assets.
We can also calculate EVA in terms of ROIC:
EVA (Operating capital)(ROIC WACC). (9-10a)
As this equation shows ,a firm adds value—that is ,has a positive EVA—if its ROIC is
greater than its WACC. If WACC exceeds ROIC, then new investments in operating
capital will reduce the firm’s value.
EVA is an estimate of a business’s true economic profit for the year, and it differs
sharply from accounting profit.^9 EVA represents the residual income that remains af-
ter the cost of allcapital, including equity capital, has been deducted, whereas ac-
counting profit is determined without imposing a charge for equity capital. As we dis-
cussed in Chapter 6, equity capital has a cost, because funds provided by shareholders
could have been invested elsewhere, where they would have earned a return. Share-
holders give up the opportunity to invest elsewhere when they provide capital to the
firm. The return they could earn elsewhere in investments of equal risk represents the
cost of equity capital. This cost is an opportunity costrather than an accounting cost,but
it is quite real nevertheless.
Note that when calculating EVA we do not add back depreciation. Although it is not
a cash expense, depreciation is a cost, and it is therefore deducted when determiningIf you want to read more
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(^9) The most important reason EVA differs from accounting profit is that the cost of equity capital is deducted
when EVA is calculated. Other factors that could lead to differences include adjustments that might be
made to depreciation, to research and development costs, to inventory valuations, and so on. These other
adjustments also can affect the calculation of investor supplied capital, which affects both EVA and MVA.
See Stewart, The Quest for Value, listed in the Selected Additional References at the end of the chapter.