Creation of shareholder value; this simple idea has become a principle of corporate governance over the past fifty years (Lazonick et al, 2000). Managers shall maximize the value of their business by efficiently allocating resources and hence increase the wealth of shareholders (Worthington et al, 2001). The operationalization of this objective is done by various indicators. Shareholders, managers and other interested parties strongly follow these in order to assess business and predict future performance. EVA is one of these indicators.
The following paper presents the concept and measurement behind the trademark EVA. It is practically applied for the company Fresenius in a simplified way. Theoretical and practical analyses reveal strengths and weaknesses of measurement and concept. In general it can be said that EVA is one approach to identify value creation and degrading. The concept can be used for investment decisions as well as performance appraisal. Main disadvantage has been identified to be a high degree of complexity in order to derive the true EVA. If adjustments are not made the measurement appears to be similar to other residual income indicators.
Table of Contents
1 Introduction
2 Theoretical conception of EVA
3 Calculation of the measurement
3.1 Rate of return - r
3.2 Cost of capital – WACC and CAPM
3.3 Conversions in the measurement
4 Application of EVA – example Fresenius
4.1 Indicating the critical parameter for Fresenius
4.2 Calculation of the measurement EVA
4.3 EVA compared to other measurements
5 Evaluation of the concept
5.1 Strengths of EVA
5.2 Weaknesses of EVA
6 Summary
Objectives and Topics
This paper aims to explore the Economic Value Added (EVA) concept to determine its efficacy as a financial performance and value creation tool compared to conventional methods. By conducting theoretical analyses and applying the concept to the medical care company Fresenius, the study investigates the strengths and weaknesses of the EVA measurement framework.
- Theoretical foundations of EVA and its implementation.
- Methodology of calculating EVA, including NOPAT and WACC.
- Practical application of the EVA concept using Fresenius as a case study.
- Comparative analysis of EVA against traditional performance metrics.
- Critical evaluation of the advantages and limitations of the EVA model.
Excerpt from the Book
3 Calculation of the measurement
Stern et all define the EVA measurement as “the after-tax cash net operating profit less a charge for capital employed to produce those profits […] The capital charge is the required or minimum rate of return necessary to compensate all the firm’s investors […] for the risk of investment” (1996, p.236). There are two calculation ways leading to the same result (Stewart, 1991): the first calculation (1) measures the spread between rate of return, r, on the capital and the cost of capital, WACC, then multiplying by book value of capital employed. It is called “value spread” approach (Fackler et al, 2009, p.316).
The second calculation way (2), called “capital charge calculation”, multiplies the capital employed directly by rate of return, resulting into the net operating profit after tax (NOPAT), and cost of capital. Both calculations do not distinguish between equity and debt capital, therefore gives same information to owners as well as investors.
Chapter Summary
1 Introduction: This chapter introduces the concept of EVA as a tool for shareholder value creation and outlines the research objective to explore its strengths and weaknesses through theoretical analysis and practical application.
2 Theoretical conception of EVA: This section explains the logic behind EVA, focusing on residual income measurement and the alignment of management incentives with shareholder wealth via bonus systems.
3 Calculation of the measurement: This chapter details the mathematical components of EVA, specifically the rate of return, weighted average cost of capital (WACC), and the necessity of accounting conversions.
4 Application of EVA – example Fresenius: This section applies the EVA framework to Fresenius, breaking down operating, investing, and financing decisions to assess its financial performance between 2006 and 2011.
5 Evaluation of the concept: This chapter critically analyzes the advantages of EVA, such as its application across various business types, and its weaknesses, including high complexity and retrospective orientation.
6 Summary: The final chapter synthesizes the research findings, noting the discrepancy in effectiveness of EVA compared to traditional metrics and questioning its superiority over other value indicators.
Keywords
Economic Value Added, EVA, Shareholder Value, NOPAT, WACC, Cost of Capital, Capital Employed, Performance Measurement, Fresenius, Financial Management, Value Creation, CAPM, Residual Income, Accounting Conversions, Corporate Governance
Frequently Asked Questions
What is the core focus of this paper?
The paper focuses on the concept of Economic Value Added (EVA), analyzing its theoretical basis, calculation methods, and its practical effectiveness as a financial performance tool.
What are the primary thematic areas covered?
The central themes include the calculation of financial spreads, the application of EVA in real-world corporate settings (Fresenius), and a critical evaluation of its strengths and limitations.
What is the primary goal of the research?
The research aims to identify the strengths and weaknesses of Stern and Stewart's EVA concept to prove or refute its status as a superior financial performance measurement tool.
Which methodology is employed in this study?
The study utilizes a secondary research methodology, drawing on established theoretical literature and applying it practically through an analysis of the annual reports of Fresenius.
What is covered in the main section of the paper?
The main section details the mathematical derivation of EVA, provides a comprehensive application example using Fresenius' financial data, and performs a comparative analysis with other metrics.
Which keywords best describe this research?
The research is best characterized by terms such as EVA, shareholder value, NOPAT, WACC, financial management, and corporate performance measurement.
How does the acquisition of APP Pharmaceuticals in 2008 affect the EVA calculation for Fresenius?
The acquisition caused a significant drop in the rate of return due to the increased capital employed required for the takeover, demonstrating how large investment activities can temporarily impact absolute EVA figures.
Why are "conversions" essential to the EVA concept according to the text?
Conversions are necessary to remove distortions caused by conventional accounting standards—such as expensing R&D—to better reflect the true economic performance and strategy of the business.
- Citar trabajo
- Anne-Kristin Rademacher (Autor), 2012, Creation of shareholder value by application of EVA , Múnich, GRIN Verlag, https://www.grin.com/document/213654
