Now a few words about EVA and MVA.
Well, the good news is that this is the final episode of
this course where I would put some formulas on the flip chart.
Now EVA or economic value added,
this was introduced sometime in
the 80s by one consulting company
and by definition it's the following thing, I will put the formula.
It's return on invested capital,
less weight to the average cost of capital,
times total assets, minus current liabilities,
I will put like this.
Oftentimes, this is sort of ignored.
But this has a special name,
this is called capital employed.
Now, if we equal the total assets,
times return on invested capital,
this is actually, roughly speaking, the profits of the company.
Well, to be more accurate,
this is net operating profit after taxes.
And then, we come up with
the general idea of that will allow us to see the meaning of that,
the PVA is actually again this is ROIC less UEC times this what is called,
I will put capital.
Now, look at this,
so this is how much we earn on our assets,
this is how much our sources of capital are worth.
So basically, you're talking about operating more efficiently,
and creating a greater return than the cost of capital.
So this is a very clear idea.
So, if you use your assets so as to not only
cover your cost of capital but also to squeeze some more return out of that,
then you create value.
So, the meaning here is that we have
to earn more than
weighted average cost of capital,
a very clear and I would say straightforward criteria.
And, now you can see why it is widely used in the corporate world,
because, this is the sort of periodic thing,
let's say may be a quarterly thing, annual thing,
and over this period of time,
that sort of it fixes a label.
We worked nicely, and that results in the idea of creating KPIs and therefore,
it's easy to evaluate performance.
Now the bad news about PVA,
is that it's sort of a periodic thing,
so it is not cumulative,
and it clearly does not recognize growth,
namely, the present value of growth opportunities.
So, it is sort of,
I wouldn't say it's a snapshot because it actually covers some period,
but this is a short-term measure.
And being a short-term measure,
it's both a plus and the minus.
A plus is because you can easily correct your performance if for example,
for this period your EVA happens to be negative,
but on the other hand,
you have to sometimes engage in
decisions that do result in negative EVAs over some period of time,
but, the compensation will be the sort of arriving value from the future.
Now, the market value added is another thing.
And market value added is basically, by definition,
is the market value of equity,
plus the market value of debt,
less the PVA of all investments.
So here, you can see that there's a very,
very close to the idea of PVA and NPV.
And we can rewrite that,
that actually market value added is,
first of all, this is PV of all EVAs,
and this is the NPV of all free cash flows.
So basically, well, this is just the sum over T of EVA,
T over one plus the discount by UEC.
So basically, we can see that the good news about MVA is that,
it does recognise PVGO,
and this is cumulative.
So, that basically answers the question,
how much value we have created over some period of time?
And this is sort of at a longer-term view.
Now, I specifically mentioned before
that these are the ones that are widely used in the corporate world,
but, you do understand that these are just other faces of MPV.
If EVA is sort of periodic,
these formulas like that MVA is equal to NPV of free cash flows,
that just says that we're talking about one and the same major approach.
So, here we get some support to
the idea that our obsession with the use of MPV had some roots here.
It is the thing that is widely used even in corporations.
I mentioned in the previous episode,
that sometimes the direct use of MPV formulas may look somewhat cumbersome but,
these are the ways how people feel that much better but in essence, it's the same.
So now, we are comfortable to wrap this up by saying that
we will indeed use MPV as often and as possible,
and everywhere that we will try to do that as best as we can.
Because we know that as we mentioned before,
to properly use MPV,
you have to always watch the quality of your inputs.
Now here I am wrapping up with MPV,
and in the next episode,
I will try to show the steps in project valuation as we have covered them in this course.
That is sort of a reminder or let's say a collection of
these steps so that will make the use of that easier for you
if you will have the time only to see the next episode.
