Chapter Five

Part One: Business Valuation

 Business Valuation

Chapter objectives:
Explain the basic valuation framework in terms
of different concepts of value;
Describe the four major approaches to valuation
of business – asset based, earning based,
market value-based, and fair value-based;
 Introduction to Business valuations
Why do we need a valuation?
A share valuation may be needed for any of the
following:
1. For any sale or purchase of shares
2. As a price for a merger or acquisition
3. For tax purposes - e.g. capital gains, inheritance tax
4. For disclosure purposes - e.g. if directors are given
shares as part of their remuneration
5. For other legal purposes, such as divorce
settlements., etc
 Conceptual Framework Of Valuation
The term valuation implies the task of
estimating the worth/value of
 an asset,
 a security or
 a business.
The price an investor or a firm (buyer) is
willing to pay
 to purchase a specific asset/security would be
related to this value.
 Cont...
Obviously ,two different buyers may not have
the same valuation for an asset/ business as
their perception regarding its worth /value
may vary; one may perceive the
asset/business to be of higher worth (for what
ever reason) and hence may be willing to pay
a higher price than the other.
A seller would consider the negotiated selling
price of the asset/ business to be greater than
the value of the asset /business he is selling.
 Cont...
Evidently, there are unavoidable subjective
considerations involved in the task and process
of valuation.
 The task of business valuation is more awesome
than that of an asset or an individual security.
In the case of business valuation, the valuation
is required not only of tangible assets but also of
intangible assets as well as human resources
that run/ manage the business.
 Cont...
Likewise, there is an imperative need to take into
consideration recorded liabilities as well as
unrecorded/contingent liabilities so that the buyer
is aware of the total sums payable subsequent to
the purchase of the business.
A contingent liability is a liability or a potential loss
that may occur in the future depending on the
outcome of a specific event. Potential lawsuits,
product warranties, and pending investigation are
some examples of contingent liability.
Thus, the valuation process is affected by
subjective considerations.
Key questions
As finance manager
1. How to reduce the element of subjectivity?
and
2. How to carry out a more credible valuation
exercise in an objective manner?
 Cont...
In order to reduce the element of subjectivity, to a marked
extent, and help the finance manager to carry out a more
credible valuation exercise in an objective manner, the
following concepts of value are explained in this section:
i. Book value
ii. Market value
iii. Intrinsic value
iv. Liquidation value
v. Replacement value
vi. Salvage value
vii. Value of goodwill and
viii. Fair value
 Book Value
 refers to the amount at which an asset is shown in the balance sheet
of a firm.
 Generally, the sum is equal to the initial acquisition cost of an asset
less accumulated depreciation.
 Accordingly, this mode of valuation of assets is as per the going
concern principle of accounting.
 Book value of a business refers to total book value of all valuable
assets
 Excluding fictitious assets (such as accumulated loss and deferred
revenue expenditures, like advertisement, preliminary expenses,
cost of issue of securities not written off)
 less all external liabilities (including preference share capital ).
 It is also referred to as net worth.
 Market Value

In contrast to book value, market value refers to

the price at which an asset can be sold in the
market.
can be applied with respect to tangible assets
only;
intangible assets (in isolation), more often than
not, do not have any sale value.
 Market value of a business refers to the aggregate
market value of all equity shares outstanding.
 The market value is relevant to listed companies
only
 Intrinsic/ Economic Value
Intrinsic value is an estimate of the actual true value of a
company, regardless of market
Intrinsic/ economic value of an asset is equal to the present
value of incremental future cash
 It represents the maximum price the buyer would be willing
to pay for such an asset.
The principle of valuation based on the discounted cash flow
approach (economic value) is used in capital budgeting
decisions.
In the case of business intended to be purchased, its
valuation is equivalent to the present value of incremental
future cash inflows based after taxes
The economic value indicates the maximum price at which
the business can be acquired.
 Liquidation value
represents the price at which each individual
assets can be sold if business operations are
discontinued in the wake of liquidation of the
firm.
In operational terms, the liquidation value of the
a business is equal to the sum of
(i) realisable value of assets and
(ii) cash and bank balances minus the payments
required to discharge all external liabilities.
 In general, among all measures of value, the
liquidation value of an asset / or business is
likely to be the least.
 Replacement value
Replacement value the cost of acquiring a new
asset of equal utility and usefulness.
 It is normally useful in valuing tangible assets
Salvage value
Salvage value represents realisable/scrap
value on the disposal of assets after the expiry
of their economic useful life.
 It may be employed to value assets such as
plant and machinery.
Salvage value should be considered net of
removal costs.
 Value of goodwill
The valuation of goodwill is conceptually the most difficult.
 A business firm can be said to have ‘real’ goodwill in case it earns a rate
of return (ROR) on invested funds higher than the ROR earned by similar
firms (with the same level of risk).
 In operational terms goodwill results when the firm earns excess
(‘super’) profits.
the value of goodwill is equivalent to the present value of super profit
The value of goodwill in terms of the present value of super profits
method can serve as a useful benchmark in terms of the amount of
goodwill the firm would be willing to pay for the acquired business.
In the case of mergers and acquisition decisions,
 the value of goodwill paid is equal to the net difference between the
purchase price paid for the acquired business and the value of assets
acquired net of liabilities the acquiring firm has undertaken to pay for.
 Fair value
The concept of ‘fair’ value draws heavily on the
value concepts discussed above, in particular,
book value, intrinsic value and market value.
The fair value is hybrid in nature and often the
average of these three values.
Ideally, business valuation should be related to
the cash flow generating ability of acquired
business.
 The intrinsic value reflects the firm’s capacity to
generate cash flows over the long run and,
hence, seems to be more aptly suited for
business valuation.
 Cont...
In fact, in general, business firms are not acquired with the intent
to sell their assets in the post acquisition period.
They are to be deployed primarily for generating more earnings.
However, from the conservative point of view, it will be useful to
know the realisable value, market value, liquidation value and
other values, if the acquiring firm has to resort to liquidation.
 In brief the finance manager will find it useful to know business
valuation from different perspectives.
 For example the book value may be very relevant from
accounting/tax purpose;
 the market value may be useful in determining share exchange
ratio and
 liquidation value may provide an insight into the maximum
loss, if the business is to be wound up.
 Approaches Or Methods Of Valuation
The various approaches to valuation of business with
focus on equity share valuation are examined in this
section.
 These approaches should not be considered as competing
alternatives to the dividend valuation model.
 Instead, they should be viewed as providing a range of
values, catering to varied needs, depending on the
circumstances.
 The major approaches, namely, the
(i) asset based approach to valuation
(ii) earning based approach to valuation
(iii) market value based approach to valuation and
(iv) the fair value method to valuation are described below.
Asset-based Approach to valuation
Asset based approach focuses on determining the value of
net assets from the perspective of equity share valuation.
 What should the basis of assets valuation be, is the central
issue of this approach.
 It should be determined whether the assets should be
valued at book, market, and replacement or liquidation
value.
More often that not, they are (and should be) valued at
book value, that is, original acquisition cost minus
accumulated depreciation,
as assets are normally acquired with the intent to be used
in business and not for resale.
 Thus, the valuation of assets is based on the going concern
concept.
 Cont...
Some other value measure may be used depending on
circumstances of the case.
 For instance, if the plant and machinery outlived its
economic useful life (earlier than its initial estimated
period), and is not in use for production, it will be in
order to value the machinery at liquidation value.
Apart from tangible assets, intangible assets also need
to be valued satisfactorily.
To arrive at the net assets value, total external liabilities
(including preference share capital) payable are
deducted from total assets (excluding fictitious assets).
The company’s net assets are computed as per the
following equation:
Net assets = total assets - total external liabilities
 Cont...
The value of net assets is also known as net worth or
equity/ordinary shareholders’ funds.
Assuming the figure of net assets to be positive, it implies the
value available to equity shareholders after the payment of all
external liabilities.
Net assets per share can be obtained, dividing net assets by the
number of equity shares issued and outstanding. Thus,
Net assets per share = net assets/ number of equity shares issued
and outstanding
The value of net assets is contingent upon the measure of value
adopted for the purpose of valuation of assets and liabilities.
 In the case of book value, assets and liabilities are taken at their
balance sheet values.
 In the market value measure, assets shown in the balance sheet
are revalued at the current market prices.
 Cont...
For the purpose of valuing assets and liabilities, it will be useful for a
finance manager/valuer to accord special attention to the following
points:
(i) While valuing tangible assets consider aspects related to
technological obsolescence and capital improvements made in the
recent years.
(ii) is the valuation of goodwill satisfactory, given the amount of
profits, capital employed and average rate of return available on such
businesses?
(iii) With respect to current assets, are additional provisions required
for “unrealisability” of debtors? Likewise, are adjustments required
for “unsalable” stores and stock?
(iv) With respect to liabilities, there is a need for careful examination
of ‘contingent liabilities
Similarly, adjustments may be required on account of guarantees
invoked, income tax, sales tax and other tax liabilities that may arise.
 Cont...
The net assets valuation based on book value is in
tune with the going concern principle of
accounting.
 In contrast, liquidation value measure is guided by
the realizable value available on the winding up/
liquidation of a corporate firm.
Liquidation value is the final net asset value (if any)
per share available to the equity shareholder.
The value is given as per the following equation:
Net assets per share = (liquidation value of assets –
liquidation expenses- total external liabilities)/
number of equity shares issued and outstanding.
 Cont...
In the case of liquidation, assets are likely to be
sold through an auction.
 In general, they are likely to realize much less
than their market values.
 This apart, sale proceeds from assets are further
dependent on whether the company has been
forced to go into liquidation or has voluntarily
liquidated.
In the case of the ‘former’ type of liquidation,
the realizable value is likely to be still lower.
The net asset value (NAV) per share will be the
lowest under the liquidation value measure.
Illustration :
Following is the balance sheet of hypothetical company limited as on
march 31, of current year: (amount in thousands):
Assets Amount Liabilities and capital Amount
Fixed Assets 1500 Share capital 40,000 11% preference shares of
Less: depreciation 300 1200 br. 100 each, fully paid up 400
current asset 120,000 equity shares of br.100 each, fully paid up 1200
Stocks 1000 retained earning 230
Debtors 500 10% Debentures 200
Cash and bank 100 1600 trade creditors 720
Preliminary expense 30 provision for income tax 80
2830 2830
 
 Cont...
Additional information:
i. A firm of professional values has provided the following
market estimates of its various assets fixed assets: br. 13
million, stocks br.12 million, debtors’ br.4.5 million. All other
assets are to be taken at their balance sheet values.
ii. The company is yet to declare and pay dividend on
preference shares
iii. The values also estimate the current sale proceeds of the
firm’s assets, in the event of its liquidation: fixed Assets br.
10.5 million, stock br.9 million, debtors’ br.4 million. Besides
the firm is to incur br. 1.5 million as liquidation cost
You are required to compute the net assets value per share
as per book value, market value and liquidation value bases.
SECTION ONE.docx
 Solution:
Determination of net asset value per share (Br.in ten thousands)
(I) Book value basis
Fixed Assets net 1200
Current assets:
Stocks 1000
Debtors 500
Cash and bank 100 1600
Total assets 2800
Less: External Liabilities:
10% debentures 200
Trade creditors 720
Provision for taxation 80
11% preference share capital 400
Dividend on preference shares (0.11 ×4 million) 44 1444
Net assets available for equity holders 1356
Divided by the number of equity shares (in ten thousands) 12
Net assets value per share (birr) 113
 (II) Market value basis
Fixed Assets net 1300
Current assets:
Stocks 1200
Debtors 450
Cash and bank 100 1750
Total assets 3050
Less: External Liabilities:
10% debentures 200
Trade creditors 720
Provision for taxation 80
11% preference share capital 400
Dividend on preference shares (0.11 ×4 million) 44 1444
Net assets available for equity holders 1606
Divided by the number of equity shares (in ten thousands) 12
Net assets value per equity share (birr) 133.8333
 (III) Liquidation value basis
Fixed Assets net 1050
Current assets:
Stocks 900
Debtors 400
Cash and bank 100 1400
Total assets 2450 Less: External
Liabilities (listed above) : 1444
Less: liquidation costs
150
Net assets available for equity holders
856
Divided by the number of equity shares (in ten thousands)
12 Net assets value per equity share (birr) 71.3333
 CONT...
The asset based approach is intuitively appealing in
that it indicates the net assets backing per equity
share.
However, the approach ignores the future earnings
/cash flow generating ability of the company’s assets.
In fact, the assets acquisition by business firms are not
an end in themselves; they are means to an end.
The end is value maximization and firms acquire assets
for the purpose of creating value.
 The earning based approach reckons this perspective
 Earning Based Approach To Valuation
is essentially guided by the economic proposition that
business valuation should be related to the firm’s potential
of future earnings or cash flow generating capacity.
This approach overcomes the asset based approach, which
ignores the firm’s prospects of future earnings and ability
to generate cash in business valuation.
Earnings can be expressed in the sense of accounting as
well as financial management.
 Accordingly there are two major variants of this approach:
(i) earnings measure on accounting basis and
(ii) earnings measure on cash flow (financial management)
basis.
 Cont...
Earnings measure based on accounting-
capitalization method as per this method, the
earnings approach of business valuation is based on
two major parameters, that is,
the earnings of the firm and the capitalization rate
applicable to such earnings ( given the level of risk)
in the market.
Earnings, in the context of this method, are the
normal expected annual profits.
 Normally to smoothen out the fluctuations in
earnings, the average of past earnings (say, of the
last three to five years) is computed.
 Cont...
Apart from averaging, there is an explicit need for making
adjustments, to the profits of the past years, in extraordinary items
(which are not likely to occur in the future), with a view to arriving
at credible future maintainable profits.
 The notable examples of extraordinary/ non-recurring items
include
 profits from the sale of land, losses due to sale of plant and
machinery,
 abnormal loss due to major fire, theft or natural calamities,
 substantial expenditure incurred on the voluntary retirement
scheme (not to be repeated) and
 abnormal results due to strikes and lock outs of major competing
firm(s).
 Obviously, their non-exclusion will cause distortion in determining
sustainable future earnings.
 Cont...
Above all, it will be useful to understand the profile of the
business,
 focusing on identifying the major growth and income
drivers.
 Are such drivers likely to continue in future years?
 If not, projected profits need to be discounted.
Finally, additional income expected in the coming years-
say, due to launch of a new product-should also be
considered.
In brief, the valuer should try to familiarize him or herself
with all major factors/events that had affected
 the profits of the business in the past years and
 are likely to affect them in the future years too.
 Cont...
Determination of capitalization rate is another major
requirement of this approach.
Capitalization rate, normally expressed in
percentages,
refers to the investment sum that an investor is
willing to make to earn a specified income.
For instance, 12.5 percent capitalization rate implies
that an investor is prepared to invest br.100 to earn
an income of br.12.5
 or an acquiring firm is prepared to invest br.100 to
buy the expected profits of br.12.5 of another
business.
 Cont...
Given the risk return framework of financial decision making, businesses
that exhibit (or are exposed to) higher business and financial risks
obviously warrant a higher capitalization factor.
Conversely, businesses carrying a low degree of risk are subject to lower
capitalization factor.
There are a host of factors that affect the risk complexion including
 fluctuation in sales/earnings,
 degree of operating leverage,
 degree of financial leverage,
 nature of competition,
 availability of substitute products and their prices,
 pace of change in technology and
 the level of governmental regulations.
Thus, there are a number of internal and external factors associated with a
business that can influence the risk and, hence, the capitalization factor
 Cont...
The determination of the capitalization factor is not an easy task in
practice.
A few guidelines/principles may, however, be helpful to the valuer
in its quantification.
First, the capitalization factor for a business firm should be higher
than that of a government security (normally considered riskless).
Secondly, the capitalization factor should match/hover around the
one that is used for other firms operating in similar type of
businesses.
 In case the valuer wants to apply different capitalization rate;
there should be weighty and convincing reasons to do so.
the following equation can be used to compute the value of
business, VB (from perspective of share owners).
VB = future maintainable profits ÷ relevant capitalization factor
 Cont...
Illustration: In the current year, a firm has reported a profit of br.650,
000, after paying tax @ 35%. On close examination, the analyst
ascertains that the current year’s income includes: (i) extraordinary
income of 100,000 and (ii) extraordinary loss of 30, 000. Apart from
existing operations, which are normal in nature and are likely to
continue in the future, the company expects to launch a new product in
the coming year.
Revenue and cost estimates in respect of the new product are as follows:
Sales br.600, 000
Material cost150,000
Labor cost (additional) 100,000
Allocated fixed cost 50,000
Additional fixed costs 80,000
From the given information, compute the value of the business, given
that capitalization rate applicable to such business in the market is 15
percent.
 Solution: Valuation of business
Profit before tax (br. 650,000/ (1- 0.35) 1,000,000
Less: extraordinary income (not likely to accrue in future) (100,000)
Add: extraordinary loss (non-recurring in nature) 30,000
Add: incremental income expected from the launch of the new product:
Sales br. 600,000
Less: incremental costs:
Material costs 150,000
Labor costs 100,000
Fixed costs (additional) 80,000 330,000 270,000
Expected profit before tax 1,200,000
Less: taxes (35%) 420,000
Future maintainable profit after taxes 780,000
Relevant capitalization factor 0.15
Value of business (br.780, 000/0.15) 5,200,000
 Cont...
Some useful insights into estimate of capitalization rate can be
made by referring to the price earnings (P/E) ratio.
The reciprocal of the P/E ratio is indicative of the capitalization
factor employed for the business by the market.
In the illustration above, the P/E ratio is approximately 6.67 (1/0.15).
The product of future maintainable profits, after taxes, br.780, 000
and the P/E multiple of 6.67 times, yields 520, 000.
 Given the fact that P/E ratio is widely used measure, it is elaborated
below.
Price earnings (P/E) Ratio the P/E ratio (also known as the P/E
multiple) is the method most widely used by finance managers,
investment analysts and equity shareholders to arrive at the
market price of an equity share.
 The application of this method primarily requires the determination
of earnings per share (EPS).
 Cont...
The EPS is computed as flows
EPS = net earnings available to equity shareholders during the
period/ number of equity shares outstanding during the period

The net earnings/profits are after deducting taxes, preference

dividend, and after adjusting for exceptional and extraordinary
items (related to both incomes and expenses/losses) and
minority interest .
 Likewise, appropriate adjustments should be made for new
equity issues or buybacks of equity shares made during the
period to determine the number of equity shares.
The EPS is to be multiplied by the P/E ratio to arrive at the
market price of equity shares (MPS)
MPS = EPS × P/E ratio
 Cont..
A high P/E multiple is suggested when the investors
are confident about the company’s future
performance/prospects and have high expectations of
future returns;
high P/E ratios reflect optimism.
On the contrary, a low P/E multiple is suggested for
shares of firms in which investors have low confidence
as well as expectations of low returns in future years;
 low P/E ratios reflect pessimism.
The P/E ratio may be derived given the MPS and EPS
P/E ratio = MPS/EPS
 Earnings measure on cash flow
(financial management) basis.

• It takes in to account evaluation of a project proposal

by considering future cash flows discounted using
available discount rate
• Book value of a firm=
Market Value Based Approach To Valuation
where we assume that the market is efficient,
so use market information (such as share prices
and P/E ratios) for the target company and
other companies.
The assumption is that the market values
businesses consistently so, if necessary,
 the value of one company can be used to find
the value of another.
 Fair Value Method to Valuation
The fair value method is not an independent
method of share valuation like those discussed
above.
This method uses the average/weightage
average or one or more of the above methods.
This method uses the average concept, its
virtue is that it helps in smoothening out wide
variations in estimated valuations as per
different methods.
 Cont...
In other words, this approach provides, in a way,
the balanced figure of valuation.
In general, this method has limited application
for business valuation.
For instance, this method of valuation of shares
had been used till the early 1990’s, for fixing the
price of new equity issues.
 Cont...
To sum up, no one method is appropriate for all
circumstances/situations/ requirements.
 Therefore, it is important to recognize that the
different methods are based on different
assumptions and depending on the
circumstances, some methods may be more
appropriate than others.
 Cont...
 For instance, where there is paucity of information about profits,
say
(i) in the case of new companies whose accounts do not serve as a
guide to future profits,
(ii) in the case of companies operating at a loss with no prospects of
earning profits in the near future and
(iii) in the case of companies having unrealistic statistics of profits
owing to factors such as disruption of business, the net asset
method of valuation seems would be more appropriate.
 In normal situations, the DCF (based on free cash flows) method
would be suitable.
 In the event of wide variations in the valuations as per these
two methods, the fair value method may be used.
 In fact, it is useful for the finance
manager/investor/valuer/analyst to know a range of values from
various perspectives.
 1.3.Other Approaches To Value Measurement
In recent years, a number of new
approaches/techniques/methods to measure value
(with focus on share holders) have been developed
and practiced.
The two major approaches are
i. market value added (MVA) and
ii. economic value added (EVA).
Market value added approach (MVA)
measures the change in the market value of the firm’s
equity vis-à-vis equity investment (consisting of equity
share capital and retained profits) accordingly,
MVA = market value of firm’s equity – equity capital
investment/ funds
 Cont...
Though the concept of MVA is normally used in the context of
equity investment (and, hence, is of greater relevance for
equity shareholders),
 it can also be adapted (like other previous approaches) to
measure value from the perspective of providers of all invested
funds (i.e., preference share capital and debt).
MVA = {Total market value of firm’s securities - (equity
shareholders funds + preference share capital + debentures)}
The MVA approach cannot be used for all types of firms.
 It is applicable to only firms whose market prices are available.
In that sense, the method has limited applications.
Besides, the value provided by this approach may exhibit wide
fluctuations, depending on the state of the capital
market/stock market in the country.
 Illustration:
Suppose: supreme industries has an equity market capitalization of br.
3.4 million in current year. Assume further that its equity share capital
is br. 2 million and its retained earnings are br. 600 thousands.
Determine the MVA and interpret it
Solution
MVA = (Br. 3.4 million – br 2.6 million) = br. 800 thousands
The value of br.800 thousands implies that the management of
supreme industries has created wealth/ value to the extent of br.
800 thousands for its equity share holders.
Well managed companies having good growth prospects and
perceived so by the investors, have positive MVA.
 Investors may be willing to pay more than the net worth.
In contrast, companies relatively less known or engaged in businesses
that do not hold future growth potentials may have negative MVA.
 Illustration
Suppose: hypothetical limited has equity market
capitalization of br. 900 thousands in the current year.
Its equity share capital and accumulated losses are of
br.1.2 million and Br. 200 thousands respectively.
Determine the MVA of the firm
Solution:
MVA = (br.900, 000-br.1, 000,000) = (- br 100,000)
 The firm has negative MVA of br. 100,000. The investors
discount its value /worth, as it is loss incurring firm.
The market value added approach reflects market
expectations and is essentially a future-oriented and
forward looking approach.
 Economic value added (EVA)
The EVA method is based on the past performance of the
corporate enterprise.
The underlying economic principle in this method is to
determine whether the firm is earning a higher rate of return
on the entire invested funds than the cost of such funds
( measured in terms of the weighted average cost of capital,
WACC).
 If the answer is positive, the firm’s management is adding to
the shareholders value by earning extra for them.
 On the contrary, if the WACC is higher than the corporate
earning rate, the firm’s operations have been eroded the
existing wealth of its equity shareholders.
the method attempts to measure economic value added (or
destroyed) for equity shareholders, by the firm’s operations, in
a given year.
 Cont...
Since WACC takes care of the financial costs of all sources
of providers of invested funds in a corporate enterprise,
it is imperative that operating profit after taxes ( and not
net profit after taxes) should be considered to measure
EVA.
 The accounting profits after taxes, as reported by the
income statement, need adjustments for interest costs.
 The profit should be the net operating profits after taxes
and
the cost of funds will be product of the total capital
supplied (including retained earnings) and WACC.
EVA = (net operating profits after taxes – (total capital
×WACC)
 Illustration:
following is the condensed income statement of a firm
for the current year:
Sales revenue br.5, 000,000
Less: operating costs 3,000,000
Less: interest costs 120,000
Earnings before taxes1,880,000
Less: taxes (0.40) 752,000
Earnings after taxes 1,128,000
The firm’s existing capital consists of br.1, 500,000
equity funds, having 15% cost and of br. 1,000,000
12% debt.
Determine the economic value added during the year.
 Solution:
(i) Determination of net operating profit after taxes
Sales revenue br.5, 000,000
Less: operating costs 3,000,000
Operating profit (EBIT) 2,000,000
Less: taxes (0.40) 800,000
Net operating profit after taxes (NOAT) 1,200,000
(ii) Determination of WACC
Equity (br. 1,500,000 ×15%) 225,000
12% debt (br. 1,000,000×7.2%) 72,000
Total cost 297,000
WACC (297,000/2,5000,000) 11.88%
Cost of debt = 12% (1-0.4 tax rate) = 7.2 percent
(iii) Determination of EVA
EVA = NOPAT – (total capital ×WACC)
Br.1, 200,000 – (2,500,000× 11.88%)
Br. 1,200,000- 297,000 = br. 903,000
 Cont...
During the current year, the firm has added an economic
value of br.903,000 to the existing wealth of the equity
shareholders.
 Essentially, the EVA approach is a modified accounting
approach to determine profits earned after meeting all
financial costs of all the providers of capital.
Its major advantage is that this approach reflects the true
profit position of the firm .
 What may happen is that the firm may exhibit positive
profits after taxes ( as per the conventional income
statement) ignoring costs of shareholders funds,
 giving an impression to the owners as well as outsiders that
the firm ‘s operations are profitable.
The profit picture ,in fact, may be illusory.