BUS601: Financial Management

Theoretically, MVA is identical or equal to the present value of all future EVAs. MVA can be calculated as perpetuity based on the assumption that the expected future growth in EVA will be at a constant rate.

Example

Company D has a current EVA of LKR 180 million. Its Weighted Average Cost of Capital (WACC) is 18%. The theoretical MVA can be calculated as follows if no future growth in EVA is expected:

 In this case, MVA is 5.5 times of the current EVA (LKR l,000mn/LKR 180mn).

If EVA is anticipated to grow at a constant rate of 12% in future, MVA can be theoretically calculated as follows:

MVA = PV (Future EVA)

= Current EVA/(WACC - growth rate)

= LKR 180mn/(0.18 - 0.12)

= LKR 3,000 million

With the assumption of 12% future growth in EVA, MVA is 16.7 times of the current EVA, or (LKR 3,000mn LKR 180mn). The fact that MVA is theoretically a multiple of the current EVA implies that any percentage change in EVA should cause the same percentage in MVA.

Several studies have been done by an ample number of researchers relating leverage and EVA to MVA. Irala (2005) initiated a study on whether EVA possesses a better explanatory power relative to the conventional accounting measures like earnings per share, return on net worth, capital productivity and labor productivity. The results supported that as compared to the other accounting measures, EVA has better explanatory power in predicting the market value.

The concept of shareholder value creation was examined by Kaur and Narang (2009) by using two value based metrics of financial performance namely EVA and MVA. For that study, 104 Indian firms were used as a sample, and the findings reveal that EVA influences the market value of shares.

The correlation between EVA and MVA of 582 American companies was examined by Fernandez (2003) over 15 years from 1983 to 1997. The NOPAT had higher correlation with changes in MVA than the EVA for 2% firms in the sample whereas for 210 sample firms the correlation between EVA and MVA was found to be negative. In line with this, a study conducted on EVA-MVA relationship of 89 industrial firms in South Africa by De Wet (2005) found that EVA did not show the strongest association with MVA.

Pachari and Navindra (2012) conducted a study on the influence of financial leverage on shareholders’ return and market capitalization of Automotive cluster companies in Pithampur. They found that there is no significant influence of financial leverage on shareholders’ return and market capitalization.

It is clear from this brief review of literature that researchers have given much emphasis to EVA while gauging shareholder value creation. In the present scenario of corporate performance and management shareholders value creation aspect is of utmost importance. Therefore no one can repudiate the inevitability of an exclusive study in this area. By recognizing this necessity an attempt has been made to investigate the relationship between EVA, leverage, and MVA.