356 CHAPTER 9 Financial Statements, Cash Flow, and Taxes
both net income and EVA. Our calculation of EVA assumes that the true economic de-
preciation of the company’s fixed assets exactly equals the depreciation used for ac-
counting and tax purposes. If this were not the case, adjustments would have to be made
to obtain a more accurate measure of EVA.
EVA measures the extent to which the firm has added to shareholder value. There-
fore, if managers focus on EVA, this will help to ensure that they operate in a manner
that is consistent with maximizing shareholder wealth. Note too that EVA can be de-
termined for divisions as well as for the company as a whole, so it provides a useful ba-
sis for determining managerial performance at all levels. Consequently, EVA is being
used by an increasing number of firms as the primary basis for determining manage-
rial compensation.
Table 9-5 shows how MicroDrive’s MVA and EVA are calculated. The stock price
was $23 per share at year-end 2002, down from $26 per share at the end of 2001. Its
WACC, which is the percentage after-tax cost of capital, was 10.8 percent in 2001 and
11.0 percent in 2002, and its tax rate was 40 percent. Other data in Table 9-5 were
given in the basic financial statements provided earlier in the chapter.
Note first that the lower stock price and the higher book value of equity (due to re-
taining earnings during 2002) combined to reduce the MVA. The 2002 MVA is still
positive, but $460 $254 $206 million of stockholders’ value was lost during 2002.
EVA for 2001 was just barely positive, and in 2002 it was negative. Operating in-
come (NOPAT) rose, but EVA still declined, primarily because the amount of capital
rose more sharply than NOPAT—by about 26 percent versus 8 percent—and the cost
of this increased capital pulled EVA down.
Recall also that net income fell somewhat from 2001 to 2002, but not nearly so
dramatically as the decline in EVA. Net income does not reflect the amount of equity
TABLE 9-5 MVA and EVA for MicroDrive (Millions of Dollars)
2002 2001
MVA Calculation
Price per share $ 23.0 $ 26.0
Number of shares (millions) 50.0 50.0
Market value of equity $1,150.0 $1,300.0
Book value of equity $ 896.0 $ 840.0
MVA Market value Book value $ 254.0 $ 460.0
EVA Calculation
EBIT $ 283.8 $ 263.0
Tax rate 40% 40%
NOPAT EBIT(1 T) $ 170.3 $ 157.8
Total investor-supplied operating capitala $1,800.0 $1,455.0
After-tax cost of capital, WACC (%) 11.0% 10.8%
Dollar cost of capital Capital (WACC) $ 198.0 $ 157.1
EVA NOPAT Capital cost ($27.7) $ 0.70
ROIC NOPAT/Operating capital 9.46% 10.85%
ROIC Cost of capital ROIC WACC (1.54%) 0.05%
EVA (Operating capital)(ROIC WACC) ($27.7) $ 0.7
aInvestor-supplied operating capital equals the sum of notes payable, long-term debt, preferred stock, and com-
mon equity, less short-term investments. It could also be calculated as total liabilities and equity minus accounts
payable, accruals, and short-term investments. It is also equal to net operating working capital plus operating long-
term assets.
See Ch 09 Tool Kit.xls
for details.
352 Financial Statements, Cash Flow, and Taxes
