# Performance Measures: An Application of Economic Value Added

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3 real value created for the owners. But, it may originate the calculation. In other words, accounting profit is required to be converted into economic profit. Under, all distortions in conventional accounting are identified and accounting profit is adjusted to make it distortion free and finally we get the amount of. Stewart defined (1990, p.137) as Net operating profit after taxes (NOPAT) subtracted with a capital charge. Algebraically, it can be stated as follows: Adjusted Adjusted Re turn NOPAT ( Rate of NOP NOP Capital ROI Capital NOP (1 T ) Capital Costs (1 T ) Capital (1 T ) [ Capital WACC ) Capital Cost WACC of Capital WACC {( R ) ( R ) (1 T ) }]...( eq. 1) From the above derivation it is clear that computation requires a lot of hurdles to be passed. Net operating profit is adjusted for accounting distortions and a charge on capital employed at the rate of weighted average cost of capital (WACC) is subtracted from NOPAT to reach to the amount of. It aims to tell about what happens to the wealth of shareholders. As per equation 1, earning a return greater than the cost of capital increases value for the owners and vice versa. For listed companies Stewart defined another measure that assesses if the company has created shareholder value. If the total market value of a company is more than the amount of capital invested in it, the company has managed to create shareholder value. If the case is opposite, i.e., the market value is less than the amount of capital invested; the company has destroyed shareholder value. Stewart (1990, p.153) calls it as Market Value Added (MVA) and can be equated as follows: MVA Market Value of the Company Capital Market Value of Equity Book Value of Equity ( assu min g, Capital invested BV of Equity ) ( MV BV ) No. of Pr esent Value of In other words, shares outs tan ding Invested Market Value of Equity Book VAlue of Equity Pr esent Value of All Future.( eq. 3) MVA is identical by meaning with the market-to-book ratio. The difference is only that MVA is an absolute measure and market-to-book ratio is a relative measure. If MVA is positive that means that market-to-book ratio is more than one. Negative MVA means market-to-book ratio less than one. If a company s rate of return exceeds its cost of capital, the company will sell on the stock markets with premium compared to the original capital (has positive MVA). On the other hand, companies that have rate of return smaller than their cost of capital sell with discount compared to the original capital invested in company. Whether a company has positive or negative MVA depends on the level of rate of return compared to the cost of capital. All this applies to also. Thus positive means also positive MVA and vice versa. But, MVA is not a performance metric like, rather it is a wealth metric, measuring the level of value a company has accumulated over time. The implementation process of parallels the successful implementation of Stern Stewart 4Ms, e.g., measurement, management system, motivation and mindset. at the very beginning looks for a measurement base for converting accounting profits into economic reality. Without commitment from management, the implementation of is impossible. Management system should be streamlined with the basic philosophy. It should be guaranteed that the application of is well accepted by all. And finally, mindset should be cultivated into the corporate culture to make it the focal point for reporting, planning and decision-making. 4. as a Management Tool is superior to accounting profits as a measure of value creation because it recognizes the cost of capital and, hence, the riskiness of a firm s operations (Lehn & Makhija, 1996, p.34). It is used as a value based performance measure tool more widely. In this context, is compared with some traditional measures and with some other value based measures as well. 4.1 vs. Traditional Measures is based on the common accounting based items like interest bearing debt, equity capital and net operating profit. It differs from the traditional measures mainly by including the cost of equity. Salomon and Laya (1967) studied the accounting rate of return (ARR) and the extent to which it approximates the true return measured with IRR. Harcourt (1965), Solomon and Laya (1967), Livingston and Solomon (1970), Fischer and McGowan (1983) and Fisher (1984) e All Future...( eq. 2) E CE d D CE 171

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