Economic Value Added (EVA) is aimed to be a measure of the wealth of shareholders. According to this theory, earning a return greater than the cost of capital increase value of company while earning less than the cost of capital decreases the value. For listed companies, Stewart defined another measure that assesses if the company has created shareholder value or not. 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. However, if market value is less than capital invested, the company has destroyed shareholder value. The difference between the company’s market value and book value is called Market Valued Added or MVA.
From an investor’s point of view, Market Value Added (MVA) is the best final measure of a Company’s performance. Stewart states that MVA is a cumulative measure of corporate performance and that it represents the stock market’s assessment from a particular time onwards of the net present value of all a Company’s past and projected capital projects. MVA is calculated at a given moment, but in order to assess performance over time, the difference or change in MVA from one date to the next can be determined to see whether value has been created or destroyed.
The Market Value Added (MVA) measure is based on the assumption that the total market value of a firm is the sum of the market value of its equity and the market value of its debt. Stewart defines Market Value Added (MVA) as the excess of market value of capital (both debt and equity) over the book value of capital.
Simply stated, Market Value Added (MVA) = Market value of the company – Capital invested in the company
- Market value : For a public listed company it is calculated as the number of shares outstanding x share price + book value of debt (since market value of debt is generally not available). In order to calculate the market value of a firm, we have to value the equity part at its market price on the date the calculation is made. The total investment in the Company since day one is then calculated as the interest-bearing debt and equity, which includes retained earnings. Present market value is then compared with total investment. If the former amount is greater than the latter, the Company has created wealth.
- Capital invested : It is the book value of investments in the business made up of debt and equity.
Effectively, the formula becomes, Market Value Added (MVA) = Market value of equity – Book value of equity
According to Stewart, Market Value Added (MVA) tells us how much value company has added to or subtracted from its shareholders investments. Successful companies add their MVA and thus, increase the value of capital invested in the company. Unsuccessful companies decrease the value of capital originally invested in the company. Whether a company succeeds in creating MVA (increasing shareholder value) or not, depends on its rate of return. If a company’s rate of return exceeds its cost of capital, the company will sell on stock markets with premium compared to the original capital and thus, have 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 the company.
Market Value Added (MVA) is an cumulative measure of corporate performance and that it represents the stock markets assessments from a particular time onwards of the net present value of all of a Company’s past and projected capital projects. The disadvantage of the method is that like EVA there can be a number of value based adjustments made in order to arrive at the economic book value and that it is affected by the volatility from the market values, since it tends to move in tandem with the market.
Relationship between Economic Value Added (EVA) and Market Value Added (MVA)
Whether a company has positive or negative Market Value Added (MVA) depends on the level of rate of return compared to the cost of capital. All this applies to Economic Value Added (EVA) also. Stewart has defined relationship between EVA and MVA. When a business earns a rate of return higher than its cost of capital, EVA is positive. In other words, investors are earning more than their investment in that business than they could elsewhere. In response, investors bid up share prices, increasing the value of their business and driving up its MVA. Similarly, investors discount the value of businesses that earn a return below their cost of capital.
Thus, MVA is an estimate made by the investors of the net present value of all current and expected future investments in the business. In other words, it can be said that MVA is same as NPV and can be calculated as the present values of all future EVAs. Similarly, it can be the present value of future free cash flows, because discounted EVA and discounted free cash flows are mathematically equivalents.
From the definition of Market Value Added (MVA) , value of firm can be expressed as Market Value = Capital + MVA of firm.
However, MVA is the present value of all future EVAs. Therefore, the value of the firm can be expressed as sum of its capital; current EVA capitalized as perpetuity and the present value of all the expected future EVA improvements.
Market Value = Capital + Value of current EVA as perpetuity+ Present value of expected EVA Improvement
Since, market value is dependent on market implications of all future performance, market values are sensitive to the changes in current EVA as well as expected EVA improvement. This results in an interesting problem for the managements. They need to decide the level of focus on generating current results and future prospects. The solution seems to be clear. Management must focus on producing best results today a while making significant efforts for future simultaneously. The stress has to be on long term and short term perspective both.
In a nutshell, relationship between Economic Value Added (EVA) and Market Value Added (MVA) can be summarized as follows:
- The relationship between EVA and MVA is more complicated than the one between EVA and he firm value.
- MVA of a firm reflects not only expected EVA of assets in place but also expected EVA from future projects.
- To the extent that the actual EVA is smaller than expected EVA, the market value can decrease even if EVA is higher.
Market Value Added (MVA) is, thus, in a way best performance measure because it focuses on cumulative value added or lost on invested capital. It is the difference between the capital investors have put in business (cash in) and the value they could get by selling their claims (cash out). It is a focus on wealth in dollar or rupees rather than rate of return in percentage. It, therefore, recognizes all value adding investments even if than original rate of return.