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EVA as a performance tool &

as an indicator of SWM

Course: Corporate Finance

Submitted To: Dr. Sandeep Goel

Group 1

Name

Roll No

Arindam Bera 15PGHR09 Ashmeet Singh 15PGHR14 Hansika Jain 15PGHR17 Parul Jain 15PGHR31 Shrutkirti Kothari 15PGHR42 Vipul Verma 15PGHR51

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Corporate Finance Project | Group 1 Page 2

Acknowledgement

We take this opportunity to express our gratitude to Dr. Sandeep Goel for his invaluable guidance, excellent supervision and constant inspiration throughout the course. He helped all of us to understand the elements of Corporate Finance and the issues involved with it. His encouragement and advice helped us throughout the project, and helped us in the timely completion of the project.

We thank MDI Administration and the Library Staff for maintaining such an excellent repository for Corporate Finance related material & EBSCO, without which the project would not have been possible. Last but not the least, we thank all those who were directly or indirectly involved in the completion of this project.

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Corporate Finance Project | Group 1 Page 3

Contents

Acknowledgement ... 2

Executive Summary ... 4

EVA (Economic Value Added) ... 5

Introduction ... 5

EVA: ... 5

Significance of EVA ... 5

EVA Calculation ... 5

EVA = NOPAT - Cost of Capital ... 5

WACC = Ke * W1 + Kd (1 - T) * W2 ... 6

Advantages of EVA Reporting ... 6

Limitations of EVA Reporting ... 6

Relationship between Market Price and EVA ... 6

EVA Trend Analysis ... 7

Hindustan Unilever Limited ... 7

EVA (Rs. Crore) vs FY | Source: HUL Annual Reports ... 7

Coca Cola Limited ... 7

EVA (Rs. Crore) vs FY | Source: Coca Cola Annual Reports ... 7

Market Performance Analysis (Using SPSS) ... 8

Hindustan Unilever Limited ... 8

Coca-Cola ... 9

Operating Efficiency Analysis ... 9

5 Year Trend of Current Ratios ... 10

Working Capital Analysis - Management Approach ... 11

Total Debt : 5 Year trends ... 11

Conclusion & Recommendations ... 12

References ... 13

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Corporate Finance Project | Group 1 Page 4

Executive Summary

In this report we have studied the relationship between EVA and Shareholders Wealth Maximization or SWM. SWM has been compared using the closing price of the market of the chosen companies during the financial year.

The following objectives were accomplished in this report:  Economic Value Added (EVA)

 EVA Trend Analysis

 Operational Efficiency Analysis  Market Performance Analysis

 Management Approach & Recommendations

We have taken into consideration 2 FMCG companies, HUL and Coca-Cola for the analysis. This was done to include one Indian and one foreign company. The closing price index was taken from the Bombay Stock Exchange (BSE) for HUL and the Securities Exchange Board (SEB) for Coca-Cola. The EVA trend analysis was done using the data obtained from the Annual reports of the two

companies. To analyze the data, statistical tools and techniques like simple linear regression, correlation coefficient and adjusted R2 were used. The share price was taken as the dependant variable (y) and the EVA as the independent variable (x) to determine the relationship between the two.

For Operational Efficiency analysis, current ratios of the two companies have been analyzed.

For Market Performances have been analyzed using the EVA and Closing price and then plotting them for a period of 5 years.

For Management Approach, the working capital management by the companies has been looked upon. Finally, it was concluded that EVA has a positive impact on SWM and the investors should consider this as an indispensable parameter before making any decisions related to investment or disinvestment. Moreover, the PAT sometimes gives a misleading picture as it also includes non-operating income which might create confusion for any investment related decision making and also does not include the Cost of Equity.

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Corporate Finance Project | Group 1 Page 5

EVA (Economic Value Added)

Introduction

Economic Value Added (EVA) is the financial performance measure that captures the true economic

profit of any company closest to the actual and is the performance measure which is most directly linked to creating shareholder wealth over time. There has been several studies which show the connection between change in shareholder wealth and EVA.

EVA:

 Is a value based performance measure appreciating value created by management for its owners

 Evaluates how a company is performing by maximizing wealth for its shareholders  Is most directly linked to creating shareholder wealth

A number of giant organizations, both in India and abroad report EVA in their annual reports. A few examples include HUL, Godrej, TCS in India, whereas outside, companies like Coca Cola, PepsiCo, Eli Lily, ANZ Bank have all implemented EVA financial management systems.

Significance of EVA

EVA has the following critical aspects linked to it:

 It helps organizations determine the actual profit once the taxes and capital amount has been taken under consideration

 It separates bonus plans from budgetary targets and covers all aspects of the business cycle  It helps in taking better assessment of decisions that affect the balance sheet and income

statement or tradeoffs between each through the use of the capital charge against NOPAT  A positive EVA indicates that the business has created wealth for the shareholders, whereas a

negative EVA means that the business has destroyed wealth for shareholders

EVA Calculation

In mathematical terms, this concept is expressed as (Maheswari, 2009) -

EVA = NOPAT - Cost of Capital

Where,

EVA = Economic Value Added Cost of Capital = Capital Employed x WACC NOPAT = Net Operating Profit After Tax WACC = Weighted Average Cost of Capital

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Corporate Finance Project | Group 1 Page 6

WACC = Ke * W1 + Kd (1 - T) * W2

Where,

W1 = Weight of Equity W2 = Weight of Debt

Kd = Effective cost of debt Ke = Effective cost of equity

Advantages of EVA Reporting

1. Provides a summary of how much and from where a company created wealth 2. Relatively easy to calculate

3. Can be used for compensating management

4. Includes the balance sheet in the calculation thereby encouraging managers to think about assets as well as expenses in their decisions

5. Can be used as a management tool to improve performance

Limitations of EVA Reporting

1. Economic Value Added only applies to the period measured; it is not predictive of future performance

2. Seemingly infinite cash adjustments associated with calculating economic value can be time consuming

3. Requires accurate estimate of After tax cost of capital

4. Does not take into account the effects of inflation, investment profile or currency effects on accounting value of capital and accounting profit

Relationship between Market Price and EVA

EVA and market price usually have a direct correlation. As the company's expected EVA becomes higher, so does the market value. However, under exceptional circumstances, it might be possible that -

 A positive EVA is accompanied by a fall in the market price and vice versa, due to market outlooks or growth potential

 Thus a positive change in EVA is better than a positive yet unchanging base level of EVA as it is consistent with shareholder value added

In theory, EVA and Market Price walk hand in hand, up or down, however, as discussed, due to positive market outlook or investors recognizing huge growth potential in the firm might reverse that trend and negative EVA can also result in a positive Market price.

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Corporate Finance Project | Group 1 Page 7

EVA Trend Analysis

Hindustan Unilever Limited

EVA (Rs. Crore) vs FY | Source: HUL Annual Reports

Coca Cola Limited

EVA (Rs. Crore) vs FY | Source: Coca Cola Annual Reports

1750 2250 2926 3147 3380 0 500 1000 1500 2000 2500 3000 3500 4000 2010-11 2011-12 2012-13 2013-14 2014-15

EVA Trend

EVA Trend Poly. (EVA Trend)

5201 4968 4257 2227 2081 0 1000 2000 3000 4000 5000 6000 2010-11 2011-12 2012-13 2013-14 2014-15

EVA Trend

EVA Trend Poly. (EVA Trend)

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Corporate Finance Project | Group 1 Page 8

Market Performance Analysis (Using SPSS)

Correlation EVA and Market Price usually have a direct correlation. We measure this correlation to check the extent of EVA impact on Share Price & hence the Shareholder Wealth

Adjusted R2 Adjusted R2 is used to determine the magnitude of effect of EVA on Closing Price in percentage terms

Regression Regression analysis between EVA as independent variable and Closing Price as dependant variable gives a linear equation using which we can predict the impact of EVA on SWM

Hindustan Unilever Limited

Correlation 0.957 Adjusted R2 0.888 Regression CP = 0.128 EVA - 116.27 1750 2250 2926 3147 3380 284.6 409.9 466.1 603.6 624.3 0 500 1000 1500 2000 2500 3000 3500 4000 2010-11 2011-12 2012-13 2013-14 2014-15 EVA Closing Price

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Corporate Finance Project | Group 1 Page 9

Coca-Cola

Correlation 0.4 Adjusted R2 - 0.12

Regression CP = 0.003 EVA + 41.317

Operating Efficiency Analysis

 Current Ratio (or Working Capital Ratio) is a widely used tool for evaluating short term solvency position of a business, or in other words the ability of a business to pay its short term obligations when due

 A higher Current Ratio suggests that a company is more capable to pay its obligations. An ideal ratio is 2:1

 A ratio less than 1 suggests that the company would be unable to pay off its obligations when due

 The current ratio can give a sense of the efficiency of a company's operating cycle or the ability to turn products into cash

5201 4968 4257 2227 2081 66.34 74.01 40.44 38.66 42.63 0 1000 2000 3000 4000 5000 6000 2010-11 2011-12 2012-13 2013-14 2014-15 EVA Closing Price

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Corporate Finance Project | Group 1 Page 10

Year

Current Ratio

HUL

Coca Cola

2010-11 0.86 1.05

2011-12 0.83 1.09

2012-13 0.76 1.13

2013-14 0.74 1.02

2014-15 0.75 1.24

5 Year Trend of Current Ratios

0.86 0.83 0.76 0.75 0.74 1.05 1.09 1.13 1.02 1.24 0 0.2 0.4 0.6 0.8 1 1.2 1.4 2010-11 2011-12 2012-13 2013-14 2014-15 Cu rr e n t R atio Financial Year HUL Coca Cola

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Corporate Finance Project | Group 1 Page 11

Working Capital Analysis - Management Approach

 Bank loans and financing agreements, in addition to bonds and notes that have maturities greater than one year, would be considered long-term debt

 Other securities such as repos and commercial papers would not be long-term debt, because their maturities are typically shorter than one year and are considered short-term debts  HUL has a negative Working Capital and has zero unsecured loans which show an aggressive

Approach

 Coca Cola on the other hand is financed through heavy debts (as seen in the graph) which is increasing every year, though current ratio is less than 1.3 indicating creditworthiness, conservative

Total Debt : 5 Year trends

Year

Total Debt

HUL

Coca Cola

2010-11 0 63973.71

2011-12 0 78783.22

2012-13 0 111938.8

2013-14 0 116077.84

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Corporate Finance Project | Group 1 Page 12

Conclusion & Recommendations

 EVA is one of the most important parameters which needs to be considered while taking investment decisions. This fact is even stated in the Statistical analysis performed on HUL and several other journals

 The companies which report EVAs in their balance-sheet have been able to create value for their shareholders, whereas companies which do not do so have not been able to. Therefore, it is recommended that investors look into the EVA performance of the respective companies before investing capital

 EVA takes into picture the real financial health of any company. Thus, companies should be mandatorily made to disclose EVA values in their annual reports

 Companies destroying wealth of the shareholders have a high equity cost and the profit is not enough to cover the equity cost. This implies that companies have been investing in less profitable projects

 As far as Working Capital financing is concerned, it depends on the objective of the company and is sector independent

 The main aim for any investment should be to create value for the shareholders. The managers should never consider their own profit while making an investment decision

 EVA & SWM are strongly correlated for companies to consider it before investing in them

0 0 0 0 0 63973.71 78783.22 111938.8 116077.84 119237.43 0 20000 40000 60000 80000 100000 120000 140000 2010-11 2011-12 2012-13 2013-14 2014-15 Cu rr e n t R atio Financial Year HUL Coca Cola

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Corporate Finance Project | Group 1 Page 13

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Corporate Finance Project | Group 1 Page 14

Annual Reports

https://www.hul.co.in/Images/hul-annual-report-2014-15_tcm1255-436328_en.pdf

https://www.coca-colacompany.com/content/dam/journey/us/en/private/fileassets/pdf/2

015/02/2014-annual-report-on-form-10-k.pdf

References

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