Economic Value Added

Economic Value Added

Paola Modesti (University of Parma, Italy)
Copyright: © 2014 |Pages: 6
DOI: 10.4018/978-1-4666-5202-6.ch072
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Background

A first comparison between the market value of a firm as the present value of expected dividends, as in neoclassical models, and as the economic book value plus the present value of future expected residual incomes is developed in Peasnell (1982) and in Ohlson (1995) who, together with Edwards and Bell (1961), gave origin to the residual income valuation.

About EVA and, in particular, about the equivalence between EVA and NPV, a huge literature exists, including studies which challenge Stewart’s claims (see, among others, Abdeen and Haight (2002), Biddle et al. (1997), Dodd et al. (1996), Mäkeläinen (2002) and Shrieves and Wachowicz (2001)). Adserà and Viñolas (2003) well emphasize that the two methods, although frequently assumed to be equivalent, require relevant adjustments to produce consistent conclusions.

Besides a wide theoretical debate about the validity of EVA as value indicator (see, for instance, Dierks and Patel (1997) and O’Byrne (1999)), improvements and specifications concerning the proper quantities to be considered, for instance about accounting data, have been proposed (see, among others, Cheremushkin (2008) and Warr (2005)). The model has been introduced in different fields such as banking and actuarial disciplines (see, for instance, Collins (1995)) and many empirical studies have been presented (see, among others, Kleiman (1999) and Milano (2000)).

Key Terms in this Chapter

Net Present Value (NPV): The sum of present values of the cash flows, discounted at a fixed rate, of a financial project.

Weighted Average Cost of Capital (WACC): The average of the firm’s costs of capital in which the different capitals are proportionately weighted.

Value-Driver: In the accounting literature it refers to firm’s operations which are causal factors in the creations of future profits and cash flows, like the level of new investments, the defect levels, the inventory management policies and the employee and customer relations.

Opportunity Cost of Equity: The rate at which financial resources could be invested, if not employed in the project to be valued.

Market Value Added (MVA): The sum of the present values, evaluated at the weighted average cost of capital, of all future EVA s.

Generalized Adjusted Present Value (GAPV): The Adjusted Present Value evaluated with different period opportunity costs of equity.

Adjusted Present Value (APV): The sum of present values of the cash flows, discounted at a fixed rate, of a financial project which is partially or completely financed.

Free Cash Flow (FCF): The difference between revenues and operating costs, taxes, net investments and change in working capital. It gives a measure of the (annual) change in the overall investment level and is a source for new investments.

Economic Book Value: Accounting value, the value of the assets booked in the balance sheet of the firm.

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