ISSN 23492325; DOI: 10.16962/EAPJFRM/issn.23492325/2014; Volume 6 Issue 2 (2015) www.elkjournals.com EVA? OR CVA? FOR MEASURING CORPORATE PERFORMANCE, AN EMPIRICAL STUDY Mr. Bhavesh Kumar Rathod Research Scholar (Commerce), Bharathiar University, Coimbatore, India Dr. V. Asha Research Supervisor (Commerce), Bharathiar University, Coimbatore, India Dr. J. Gajendra Naidu Research Scholar, Research Supervisor (Management), Bharathiar Univeristy, Coimbatore, India ABSTRACT There are many modern methods in valuing the performance of a company. Among them EVA and CVA are most widely used methods. Joel Stern, managing partner of M/s Stern Stewart & Co. introduced a modified concept of economic profit in 1990 in the name of Economic Value Added (EVA) as measure of business performance. In this paper, EVA as well as CVA are used to measure the performance of top 10 IT companies. It also tries to find the correlation between EVA and CVA, after calculation and analysis of the company s performance. Basis the study, Infosys failed to earn economic profit whereas TCS initially was not up to the mark but gradually tried to earn economic profit. Small companies like Rolta, Mphasis, Polarisis are gradually earning economic profit as well as there is increase in their EPS also. Companies like Wipro, Tech Mahindra, and HCL have a bright future from investors point of view as well from growth point of view. This research also reveals that there is a high degree of correlation between EVA and CVA of the companies. Keywords: CVA, Company Performance, Correlation, EPS, EVA. Introduction IT industry plays an important role in Indian economy by means of mobilizing funds, employment generation etc. In India, information technology industry provided skilled employment both in India and abroad, generating direct employment for nearly 2.8 million person and indirect employment of around 8.9 million in 2013. Indian IT and BPO sector are expected to grow by 14% in FY14 to touch around USD 87 billion. As per Nasscom, IT industry is expected to contribute US$ 100 billion to the country s GDP and generate about 22 million jobs by 2015 as per a report. A company's real economic profit or EVA is the amount it earns in excess of the cost of capital whereas CVA (Cash Value Added). It includes only cash items, i.e. Earnings Before Depreciation Interest and Tax (EBDIT), adjusted for noncash charges, working capital movement and nonstrategic investments. An enterprise creates wealth for its shareholders only when there are profits left after meeting a charge on the capital employed by the company. There is evidence that suggests that companies that have focused on earning a return on capital in excess of the cost of capital have been the most successful in consistently increasing shareholder wealth. 57
And companies that deliver shareholder returns are able to access lower cost funds thereby entering a beneficial cycle as opposed to a vicious cycle. As firms increasingly rely on the capital markets for funds, those that have provided good returns to their investors would be at an advantage in raising further resources at advantageous terms. Since the primary objective of commercial organizations is normally assumed to be the maximization of the wealth of their shareholders. In practice, many organizations use profitbased measures as the primary measure of their financial performance. Two problems relating to profit in this area of traditional methods are: Profit ignores the cost of equity capital. Companies only generate wealth when they generate a return in excess of the return required by providers of capital both equity and debt. In financial statements, the calculation of profit does take into account the cost of debt finance, but ignores the cost of equity finance. Profits calculated in accordance with accounting standards do not truly reflect the wealth that has been created, and are subject to manipulation by accountants. Economic Value Added or EVA is a performance measurement system that aims to overcome the above said two weaknesses. EVA is calculated using the formula: (1): EVA = NOPAT (Cost of Capital * Capital Employed) Where NOPAT (Net Operating Profit After Tax) is calculated by adding PAT with Interest. Cost of Capital is calculated by using CAPM model i.e. (2) Rf + (Em Rf) o Rf = Risk free return (return of 10 years govt. bonds) o = measure of Volatility considering share price and market return) o Em = Expected rate of Return Capital Employed is calculated by deducting total current liability from Total Assets If EVA is positive then that is favourable, as it means that the organization is providing a return that is greater than that required by providers of finance. It is creating wealth or Wealth is added and viceversa. The CVA for a period is a good estimate of the cash flow generated above or below the investor s requirement for that period. Note that this analysis can be done at each level of the company and that the CVA for the company is the aggregate CVA of its Strategic investments. (3) : NPV(Investment) = PV(OCF ) Investment = PV(OCF ) PV(OCFD ) = = [ OCF 1 (1 + r) +.. + OCF n (1 + r) n] [ OCFD 1 (1 + r) +.. + OCFD n (1 + r) n] = [ OCF 1 OCFD 1 +.. + OCF n OCFD n (1 + r) (1 + r) n ] = [ CVA 1 (1 + r) +.. + CVA n (1 + r) n] = PV(CVA 1..n ) The OCFD is calculated in three steps: 1. Identify the initial outlay for each strategic investment still in use in a strategic business unit. 2. Estimate each strategic investment s economic life. 3. Find which nominal cash flow each strategic investment must produce 58
every period (year/quarter/month) in order to give that strategic investment a NPV of zero in a nominal calculation. The OCFD is assumed to be the same in real terms each year. Hence, the cash flow in the nominal calculation changes only with historic outcome of inflation if the CVA analysis is made on historic data, and future estimated inflation, for the remaining OCFD. REVIEW OF LITERATURE In last 15 years many articles dealing with theory and application of EVA has been published out of which one article titled EVALiterature review and relevant issues by Dr. Anil K Sharma and Satish Kumar (2010) reviewed 112 articles on EVA from 1198 to 2008. This article explained various researches done and areas where research has to be done related to EVA. Aloy Nerash Jay and Alfered (2014) has worked on association between EVA, MVA and Leverage by taking three year data for 5 banks. A conceptual paper by Erik Ottosson paper titled Cash Value Added a new method for measuring financial performance, 1996 was also reviewed for the study. RESEARCH QUESTIONS AND HYPOTHESIS The hypotheses to be tested are derived from the notion that EVA is highly associated with shareholders return and firm value or CVA. Therefore this study poses the following question. i. Is there a significance relation between EVA and CVA? H0 There is no significant difference between EVA and CVA H1 There is a significant difference between EVA and CVA OBJECTIVE OF THE STUDY Primary objective of the study is to empirically test the assertion between EVA and company performance as CVA and Company performance. Thus, the objective of the study is threefold, I. To find the company s performance using EVA and CVA II. To examine the relationship between EVA and CVA III. To forecast the company performance using CVA and EVA RESEARCH METHODOLOGY I. Data collection and sampling design Top 10 IT company s financial statements are used from 20102014 to calculate EVA. These companies are Infosys, Oracle, HCL, Wipro, Tech Mahindra, TCS, Mindtree, Mphasis, Polaris Technology and Rolta. ANALYSIS AND INTERPRETATION This section includes analysis and interpretation of Data collected from top 10 IT companies using tables and graphs. 59
Rs. in Crores ELK ASIA PACIFIC JOURNAL OF FINANCE AND RISK MANAGEMENT Table 1: Economic Value Added Of Top 10 IT Companies (Rs. in Cr.) 2014 2013 2012 2011 2010 TCS 19.7 4784.9 1472.1 150.7 1799.5 Infosys 12.0 6675.8 792.9 857.4 412.7 Wipro 22.6 2484.4 2203.8 1242.6 44.6 Tech Mahindra 8.7 330.4 290.2 211.3 306.8 HCL 1.5 957.9 633.6 7.1 106.4 Mphasis 0.8 289.4 293.5 251.0 386.9 Oracle 7.7 478.4 251.7 448.8 371.3 Mindtree 5.5 199.5 116.2 55.1 102.4 Polarisis 0.7 87.7 79.0 2.2 21.1 Rolta 0.1 265.5 40.5 81.6 79.3 Source Calculated Figure 1: Economic Value Added Of Top 10 IT Companies (Rs. in Cr.) 6000.0 4000.0 2000.0 0.0 2000.0 4000.0 6000.0 8000.0 Conclusion: From the above table and graph where EVA of 10 companies from year 2010 to 2014 has been shown. In the graph, we can see clearly that none of the companies have incremental growth in ECONOMIC VALUE ADDED 2014 2013 2012 2011 2010 TCS Infosys Wipro Tech Mahindra HCL Mphasis Oracle Mindtree Polarisis Rolta EVA, in fact, most of the company s EVA showed a declining trend. The performance of Infosys gradually decreased from 412.7 crores in 2010 to 6675.8 crores in 2013. Performance of Wipro Company is much better compared to the other companies. 60
Rs. in Cr. ELK ASIA PACIFIC JOURNAL OF FINANCE AND RISK MANAGEMENT Rolta and Polarises did much better in adding economic profit to their companies. Investors will be showing more interest in companies like Wipro, Rolta, Polaries to invest rather than investing in companies like Infosys, TCS. Table 2: CVA of Top 10 IT Companies from 2010 to 2014 (Rs. in Cr.) 2014 2013 2012 2011 2010 TCS 5156.0 8789.9 4571.5 2334.1 97.5 Infosys 4617.1 3201.7 840.3 905.1 2121.6 Wipro 5039.8 6863.9 6297.2 4722.9 3027.0 Tech Mahindra 2227.1 1152.2 1018.2 842.9 807.5 HCL 1687.3 2467.5 1919.1 1307.4 1059.0 Mphasis 486.9 777.7 783.9 771.5 826.4 Oracle 316.5 738.8 518.2 721.5 635.4 Mindtree 317.9 559.2 420.4 301.1 284.3 Polarisis 292.6 346.5 316.0 173.5 7.6 Rolta 17.5 250.6 25.3 61.5 62.6 Source: Calculated. Figure 2: CVA of Top 10 IT Companies from 2010 to 2014 (Rs. in Cr.) 10000.0 8000.0 6000.0 4000.0 2000.0 0.0 2000.0 4000.0 CVA 2014 2013 2012 2011 2010 TCS Infosys Wipro Tech Mahindra HCL Mphasis Oracle Mindtree Polarisis Conclusion: From the above table and graph where CVA of top 10 companies from year 2010 to 2014 has been shown in the graph, we can see clearly see that from 2010 till 2013, CVA of most of the companies has upward trend and sloping down from thereafter, though the CVA of 61
Axis Title ELK ASIA PACIFIC JOURNAL OF FINANCE AND RISK MANAGEMENT Infosys company was negative till 2013 but managed to add cash from 2014. Table 3: Forecasting Of EVA from 2015 to 2020 (Rs. in Cr) Tech TCS INFOSYS Wipro Mahindra HCL Mphasis Oracle Mindtree Polaris Rolta 2010 1799.50 412.65 44.57 306.84 106.42 386.87 371.28 102.43 21.05 79.26 2011 150.66 857.41 1242.65 211.32 7.06 251.03 448.80 55.15 2.21 81.56 2012 1472.07 792.87 2203.84 290.23 633.64 293.54 251.74 116.17 79.02 40.46 2013 4784.93 6675.81 2484.43 330.37 957.89 289.43 478.39 199.54 87.66 265.53 2014 19.75 11.97 22.61 8.72 1.47 0.81 7.69 5.46 0.70 0.13 2015 3405.95 3236.10 1594.63 86.34 564.98 22.93 102.30 80.89 50.43 100.89 2016 4255.46 3733.01 1732.25 38.62 640.49 50.77 32.55 75.93 54.63 103.41 2017 5104.97 4229.93 1869.86 9.10 715.99 124.47 37.21 70.98 58.83 105.93 2018 5954.48 4726.84 2007.47 56.82 791.50 198.16 106.97 66.02 63.02 108.45 2019 2020 6803.99 5223.76 2145.09 7653.50 5720.67 2282.70 Source: Calculated 104.54 867.00 152.26 942.50 271.86 345.55 176.73 61.07 67.22 110.97 246.49 56.12 71.41 113.49 Figure 3: Forecasted EVA from 2010 to 2014 (Rs. in Cr.) 10000.00 8000.00 6000.00 4000.00 2000.00 0.00 2000.00 4000.00 6000.00 8000.00 FORECASTED EVA FROM 20152020 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 TCS INFOSYS Wipro Tech Mahindra HCL Mphasis Oracle Conclusion: From the above table and graph where forecasted value of EVA has been shown, after studying the forecasted value of top 10 IT companies, it is concluded that Infosys will not gain economic profit if they continue to go with existing polices and strategies related to capital structure. TCS has a bright future and good news for their shareholders and investors as there is continuous growth in EVA from 2015 till 2020. With that, other 62
Axis Title ELK ASIA PACIFIC JOURNAL OF FINANCE AND RISK MANAGEMENT companies also show a continuous growth in EVA Table 4: Forecasting of CVA from 2015 to 2020 (Rs. in Cr.) Tech TCS INFOSYS Wipro Mahindra HCL Mphasis Oracle Mindtree Polaris Rolta 2010 97.5 2121.6 3027.0 807.5 1059.0 826.4 635.4 284.3 7.6 62.6 2011 2334.1 905.1 4722.9 842.9 1307.4 771.5 721.5 301.1 2121.6 61.5 2012 4571.5 840.3 6297.2 1018.2 1919.1 783.9 518.2 420.4 316.0 25.3 2013 8789.9 3201.7 6863.9 1152.2 2467.5 777.7 738.8 559.2 346.5 250.6 2014 5156.0 4617.1 5039.8 2227.1 1687.3 486.9 316.5 317.9 292.6 17.5 2015 9161.6 1166.7 7040.1 2154.1 2413.1 527.5 400.0 474.2 261.4 85.1 2016 10818.9 1436.1 7656.8 2469.0 2654.8 460.2 337.9 506.7 143.9 88.0 2017 12476.2 1705.6 8273.5 2783.8 2896.4 392.9 275.9 539.3 26.5 90.9 2018 14133.4 1975.0 8890.1 3098.7 3138.1 325.6 213.8 571.8 91.0 93.8 2019 15790.7 2244.5 9506.8 3413.5 3379.8 258.3 151.8 604.3 208.5 96.7 2020 17448.0 2513.9 10123.5 3728.4 3621.4 191.1 89.7 636.9 325.9 99.6 Figure 4: Forecasted EVA from 2010 to 2014 (Rs. in Cr.) 20000.0 FORECASTED CVA FROM 20152020 TCS 15000.0 INFOSYS 10000.0 5000.0 Wipro Tech Mahindra HCL 0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Mphasis Oracle 5000.0 Conclusion: From the above table and graph where forecasted value of CVA has been shown, after studying the forecasted value of top 10 IT companies, it is 63
concluded that TCS, Wipro, HCL, Tech Mahindra, Polaris will maintain upward trend in future whereas Rolta & Oracle seems to be going down while adding value in terms of Cash in future. Table 5.1: Correlation Matrix Year TCS INFOSYS Wipro Tech Mahindra HCL 2010 2011 2012 2013 2014 EVA CVA EVA CVA EVA CVA EVA CVA EVA CVA 1799.5 97.5 412.7 2121.6 44.6 3027.0 306.8 807.5 106.4 1059.0 150.7 2334.1 857.4 905.1 1242.6 4722.9 211.3 842.9 7.1 1307.4 1472.1 4571.5 792.9 840.3 2203.8 6297.2 290.2 1018.2 633.6 1919.1 4784.9 8789.9 6675.8 3201.7 2484.4 6863.9 330.4 1152.2 957.9 2467.5 19.7 5156.0 12.0 4617.1 22.6 5039.8 8.7 2227.1 1.5 1687.3 Correlation 0.9 0.7 0.9 0.9 0.9 Table 5.2: Correlation Matrix Year Mphasis Oracle Mindtree Polaris Rolta EVA CVA EVA CVA EVA CVA EVA CVA EVA CVA 2010 2011 2012 2013 2014 386.9 826.4 371.3 635.4 102.4 284.3 21.1 7.6 79.3 62.6 251.0 771.5 448.8 721.5 55.1 301.1 2.2 173.5 81.6 61.5 293.5 783.9 251.7 518.2 116.2 420.4 79.0 316.0 40.5 25.3 289.4 777.7 478.4 738.8 199.5 559.2 87.7 346.5 265.5 250.6 0.8 486.9 7.7 316.5 5.5 317.9 0.7 292.6 0.1 17.5 Correlation 1.0 1.0 0.8 0.5 1.0 Source: Calculated 64
Figure 5: Correlation between EVA & CVA 1.5 CORRELATION 1.0 0.5 0.0 0.5 1.0 0.9 0.7 0.9 TCS INFOSYS WiproTech MahindraHCL Mphasis Oracle Mindtree Polaris Rolta 0.9 Conclusion: Table 4 exemplifies the existence of statistically significant relation among the predicted variables (EVA and CVA). Hence, H0 is accepted implies that there is a significant difference between EVA and CVA. The findings revealed that the R value for the association between EVA and CVA is found to be positive for nine companies. FINDINGS AND CONCLUSION 0.9 a) FINDINGS : IT companies play an important role in Indian economy. Contribution of IT companies has a greater impact on Indian GDP. Usually investors use EPS, ROI, ROE etc. as a tool to invest their money. These measures are good for a short term but for long term, they may not be believed. When we evaluate the performance of the company using traditional methods it may not give the clear picture. From the above calculation and analysis, most of the company s EVA is found negative, which means that those companies 1.0 1.0 EVA CVA EVA CVA EVA CVA EVA CVA EVA CVA EVA CVA EVA CVA EVA CVA EVA CVA EVA CVA 0.8 0.5 1.0 Correlation failed to earn economic profit, which is not a good sign for the investors nor for the company. There is a gradual increase in EPS, which is not sufficient for evaluating performance of the company because while calculating EPS, cost of capital, which is one of the most important factors in company s development, is not considered. b) CONCLUSION: EVA = NOPAT (WACC * Capital Employed) is the perfect equation to measure the actual performance of the company on a long term basis. Whereas CVA is suitable for evaluating the value of the firm on short term basis. Both EVA and CVA can be used by the shareholders as well as stock holders to make future decisions. Both EVA & CVA are modern tools to measure the company performance. From the given tables and graphs, Infosys Company was not found doing well from EVA point of view but CVA of the company was satisfactory. There is a threat to shareholders because of negative EVA of the company. There is a bright future 65
for the companies likes Rolta, Wipro, Mindtree, Polarisis and imphasis, as for these companies, EVA is found positive while trying to reduce the cost of capital and increasing the NOPAT. REFERENCES: [1] F. Weissenrieder, Value Based Management: Economic Value Added or Cash Value Added? Gothenburg Studies in Financial Economics, Working Paper Series 971214, 1997, pp. 142. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?a bstract_id=156288 [2] Investment 10 years bond values, 2015. http://www.investing.com/ratesbonds/india10yearbondyieldadvancedchart [3] M. Anne, A. M. Anderson, R. P. Bey and C. S. Weaver, Economic Value Added Adjustments: Much to Do about Nothing? 2005. Retrieved from http://www.lehigh.edu/~incbeug/attach ments/anderson%20eva%2047 05.pdf [4] Sharma A. K. and Kumar S. (2010), Economic Value Added (EVA) Literature Review and Relevant Issues. International Journal of Economics and Finance, 2(2), 200220. [5] Economic Times Stock Quotes, 2015. Retrieved from http://economictimes.indiatimes.com/ma rkets/stocks/stockquotes [6] Tech Mahindra Financial Statements, 2015. Retrieved from https://in.finance.yahoo.com/q/hp?s=te CHM.NS&a=02&b=31&c=2010&d=02 &e=31&f=2014&g=d [7] Investopedia History of Cash Value Added, 2015. Retrieved from www.investopedia.com/terms/c/cva.asp [8] Malik, Madhu, (2004), EVA and Traditional Performance Measures: Some Empirical Evidence, The Indian Journal of Commerce, 57(2), AprilJune 2004, 3237. [9] Venkateshwarlu, M. and Nitesh Kumar, (2004), Value Creation in Indian Enterprises An Empirical Analysis, The ICFAI Journal of Applied Finance, December 2004, 1831. [10] Copeland, T., Koller, T. & Murrin, J. (1995). Valuation. Measuring and managing the value of companies. 2nd Edition. New York: John Wiley & Sons. [11] Peter Schuster, Ph.D., and Mel Jameson, Ph.D. (2012), The Past Performance and Future Value of Companies. 66
LIST OF TABLES Table No. Content Page No. 1 Economic Value Added of top 10 IT Companies (Rs. In Crores) 60 2 CVA of top 10 IT companies from 2010 to 2014 (Rs. In Crores) 61 3 Forecasting of EVA from 2015 to 2020 (Rs. In Crores) 62 4 Forecasting of CVA from 2015 to 2020 (Rs. In Crores) 63 5.1 Correlation Matrix 64 5.2 Correlation Matrix 64 LIST OF FIGURES Figure No. Content Page No. 1 Economic Value Added of top 10 IT Companies (Rs. In Crores) 60 2 CVA of top 10 IT companies from 2010 to 2014 (Rs. In Crores) 61 3 Forecasting of EVA from 2015 to 2020 (Rs. In Crores) 62 4 Forecasting of CVA from 2015 to 2020 (Rs. In Crores) 63 5 Correlation Matrix 65 67