EVA as a performance tool & as an indicator of SWM

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 Ashmeet Singh Hansika Jain Parul Jain Shrutkirti Kothari Vipul Verma

15PGHR09 15PGHR14 15PGHR17 15PGHR31 15PGHR42 15PGHR51

EVA as a performance tool & as an indicator of SWM 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. Date: 15/03/2016

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EVA as a performance tool & as an indicator of SWM 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 Annual Reports ........................................................................................................................................... 14

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EVA as a performance tool & as an indicator of SWM

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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EVA as a performance tool & as an indicator of SWM 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

WACC used in the calculations is calculated as:

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EVA as a performance tool & as an indicator of SWM 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. 2. 3. 4.

Provides a summary of how much and from where a company created wealth Relatively easy to calculate Can be used for compensating management 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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EVA as a performance tool & as an indicator of SWM

EVA Trend Analysis Hindustan Unilever Limited

EVA Trend 4000 3500 2926

3000 2500 2000

3147

3380

2250 EVA Trend

1750

Poly. (EVA Trend)

1500 1000 500 0 2010-11

2011-12

2012-13

2013-14

2014-15

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

Coca Cola Limited

EVA Trend 6000 5201 5000

4968 4257

4000

EVA Trend

3000 2227

2081

2013-14

2014-15

Poly. (EVA Trend)

2000 1000

0 2010-11

2011-12

2012-13

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

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EVA as a performance tool & as an indicator of SWM Market Performance Analysis (Using SPSS) Correlation Adjusted R2 Regression

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 is used to determine the magnitude of effect of EVA on Closing Price in percentage terms 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 4000 3500

3380 3147

3000

2926

2500 2250 EVA

2000 1750

Closing Price

1500 1000 500 284.6

466.1

409.9

603.6

624.3

0 2010-11

Correlation Adjusted R2 Regression

2011-12

2012-13

2013-14

2014-15

0.957 0.888 CP = 0.128 EVA - 116.27

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EVA as a performance tool & as an indicator of SWM Coca-Cola 6000 5201

5000

4968 4257

4000

EVA

3000

Closing Price 2227

2000

2081

1000

0

66.34 2010-11

Correlation Adjusted R2 Regression

74.01 2011-12

40.44 2012-13

38.66 2013-14

42.63 2014-15

0.4 - 0.12 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

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EVA as a performance tool & as an indicator of SWM

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

1.4 1.24 1.2

1.13

1.09

1.05

1.02

1

Current Ratio

0.86

0.83 0.76

0.8

0.75

0.74 HUL

0.6

Coca Cola

0.4

0.2

0 2010-11

2011-12

2012-13

2013-14

2014-15

Financial Year

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EVA as a performance tool & as an indicator of SWM 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

2014-15

0

119259.43

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EVA as a performance tool & as an indicator of SWM 140000 120000

111938.8

116077.84

119237.43

Current Ratio

100000 78783.22

80000 63973.71

HUL

60000

Coca Cola

40000 20000 0

0

0

0

0

0 2010-11

2011-12

2012-13

2013-14

2014-15

Financial Year

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 Corporate Finance Project | Group 1

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EVA as a performance tool & as an indicator of SWM References

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EVA as a performance tool & as an indicator of SWM Annual Reports  https://www.hul.co.in/Images/hul-annual-report-2014-15_tcm1255436328_en.pdf  https://www.cocacolacompany.com/content/dam/journey/us/en/private/fileassets/pdf/2 015/02/2014-annual-report-on-form-10-k.pdf

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