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Unformatted text preview: that the result is
stated in dollars rather than percentages. It can be applied to the
company as a whole as well as to
specific long-term investments
such as new facilities or equipment and acquisitions.
According to its proponents,
EVA® represents “real” profits and
provides a more accurate measure than accounting profits. Over time, it also has better correlation
with stock prices than does earnings per share (EPS). Income calculations include only the cost of
debt (interest expense), whereas
EVA® uses the total cost of capital—both debt and equity (an
expensive form of capital). In addition, EVA® treats research and
development (R&D) outlays as
investments in future products or
processes and capitalizes rather
than expenses them. A growing
EVA® can signal future increases
in stock prices.
Companies that use EVA®
believe doing so leads to better
overall performance. Managers
who apply it focus on allocating
and managing assets, not just
accounting profits. They will
accelerate the development of a
hot new product even if it reduces
earnings in the near term. Likewise, EVA®-driven companies will
expense rather than capitalize the
cost of a new venture. Although
earnings will drop for a few quarters, so will taxes—and cash flow
EVA® is not a panacea, however. Its critics say it’s just another
accounting measure and may not
be the right one for many companies. They claim that because it
favors big projects in big companies, it doesn’t do a good job on
capital allocation. Each year Fortune and Stern
Stewart publish a “wealth creators” list that answers a critical
question: Is the company creating
or destroying wealth for its shareholders? This list uses both EVA®
and market value added (MVA®)—
the difference between what
investors can now take out of a
company and what they put in—to
rank companies. In 2001 the list
also included another measure,
future growth value, an estimate of
the value of the companies’ future
growth today, based on current net
operating profits after taxes.
General Electric again topped the
2001 list, followed by Microsoft,
Wal-Mart, IBM, and Pfizer.
EVA® is gaining acceptance
worldwide as well. At the French
corporation Danone, chief executive Franck Riboud uses an EVA®
formula to measure performance.
“It’s a question of tools and language,” says Riboud. “If I talk
EVA®, I will be understood all over
Sources: Geoffrey Colvin, “Earnings Aren’t
Everything,” Fortune (September 17, 2001),
p. 58; Janet Guyon, “Companies Around
the World Are Going the America Way,”
Fortune (November 26, 2001), pp. 114–120;
Randy Myers, “Measure for Measure,” CFO
(November 1997), downloaded from www.
cfonet.com; Stern Stewart Web site, www.
sternstewart.com; and David Stires,“
America’s Best and Worst Wealth Creators,”
Fortune (December 10, 2001), pp. 137–142. Review Questions
9–8 What is the internal rate of return (IRR) on an investment? How is it
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This document was uploaded on 01/19/2014.
- Fall '13