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A D DE D:
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ASSOCIATE BHARATIYA VIDYA BHAVAN
#43, RACE COURSE ROAD
BANGALORE-560 001
(2003-05)
PRINCIPAL’S CERTIFICATE
Date: (Principal)
GUIDE CERTIFICATE
Place: Bangalore
Date: (Dr. NAGESH.S.MALAVALLI)
DECLARATION BY THE STUDENT
I also declare that this report has not been submitted to any other
University or Institute for award of any Degree or Diploma.
DATE:
PLACE: (Sowmya.K)
(Reg. No. 03XQCM6098)
ACKNOWLEDGEMENT
The completion of the project would have been impossible without the
valuable contributions of people from the academics, family and friends.
(SOWMYA.K)
ABSTRACT
Market prices of the shares reflect the performance of the company. Today,
wealth created by the company is more important than the profit it earns or the
dividend it pays to the shareholders. The objective of this research is to study the
relationship that exists between the wealth/value for the shareholders created by the
company and market prices of the shares. Basic thrust of the study is to establish the
supremacy of EVA as a measure of performance over traditional measures.
ABSTRACT
1 INTRODUCTION 1-13
1.1 Introduction 2
1.2 Background of the study 3
1.3 Purpose of the study 3
1.4 Problem statement 3
1.5 Objectives of the study 4
1.6 Research Questions 4
1.7 Theoretical Framework 5-13
3 METHODOLOGY 18-26
4.1 Study Type 19
4.2 Population of the study 19
4.3 Sample Frame 19
4.4 Sampling Technique 19
4.5 Sampling Profile 20
4.6 Data Gathering Procedure 21
4.7 Hypothesis of the study 21
4.8 Testing of hypothesis 22
4.9 Description of tools used 23
4.10 Limitations of the study 26
CHAPTERS CONTENTS
PAGE NO’S
6 44-46
DISCUSSIONS AND CONCLUSIONS
45
6.1 Discussions
6.2 Conclusions 46
BIBLIOGRAPHY 47-49
List of Tables
In India, a few companies like Infosys publish EVA in its annual report
and TISCO uses EVA to measure the performance of its segments.
Background of the study
Investors are currently demanding Shareholder value more strongly
than ever. So the value created by the company is more linked to the market
price of the shares. This study is undertaken to show the relationship that
exists between the various performance metrics and the share prices as the
performance of the company is reflected in the share prices in the market.
The purpose of the study is to show that EVA has relationship with
share prices and this relationship is significant. This shows that value addition
by the company is also a dependant factor for the movement in the share
prices.
Problem Statement
Research Questions
The following are the research questions that are addressed in the study:
value-based measure. It is the surplus left after making an appropriate charge for the
invested. It is the premium the market awards a company over and above the amount
the investors have invested in it. This helps in the assessment of how the markets view
EVA generating ability of the firm. So, MVA is the market expectations of future
(1+WACC)1 (1+WACC)2
Cash Flow Return on Investment
The CFROI model avoids the use of accounting book capital in valuing the
shareholder value.
Cash Invested
Economic depreciation is the amount of annual sinking fund payment earning the cost
EVA is one measure that is used to monitor the overall value creation in
a business. It is a value based framework that provides unique insight into the
value creation. The idea behind EVA is that shareholders must earn a return
that compensates the risk taken. In other words equity capital has to earn at
least same return as similarly risky investments at equity markets. If that is not
the case, then there is no real profit made and actually the company operates
at a loss from the viewpoint of shareholders. On the other hand if EVA is zero,
this should be treated as a sufficient achievement because the shareholders
have earned a return that compensates the risk. This approach - using average
risk-adjusted market return as a minimum requirement - is justified since that
average return is easily obtained from diversified long-term investments on
stock markets. Average long-term stock market return reflects the average
return that the public companies generate from their operations.
What is EVA and how it is calculated?
EVA is the difference between the company’s net operating profits after
taxes and the cost of capital employed in generating those profits in one
financial year. If EVA is positive, the company creates shareholder wealth. If
EVA is negative, the shareholder wealth is destroyed.
To measure how much shareholder value the firm has created in the
past and to determine investor expectations as they relate to the stock price .
A firm/s present value should equal its invested capital plus the
present value of future EVA.
In stock selection the EVA tool can be used in four distinct ways.
ROE suffers from the same shortcomings as ROI. Risk component is not
included and hence there is no comparison. The level of ROE does not
tell the owners if company is creating shareholders wealth or destroying
it. With ROE this shortcoming is however much more severe than with
ROI, because simply increasing leverage can increase ROE. As we all
know, decreasing solvency does not always make shareholders’ position
better because of the increased (financial) risk. As ROI , return on equity
(ROE) is also an informative measure but it should not guide the
operations.
Stewart (1990, p.215 - 218) has first studied this relationship with
market data of 618 U.S. companies. Stewart presents the results in his book
"The quest for value". He states that EVA and MVA correspond each other in
reality quite well among US companies (the data was from late 1980’s).
Market value will always reflect the value of assets even though the company
has very low or negative rate of return (and so theoretically it should sell a lot
below book value). On the other hand markets do not believe that the weak
returns can go on forever. Markets are expecting a chance, an improvement,
in the long run. If EVA is positive, the relationship is more direct. Then the
market valuation happens on the basis of return and growth potential and not
on the basis of liquidation or recovery value. Stewart finds also that MVA and
EVA correspond each other best when we talk about changes in EVA and
MVA and not the absolute levels. Changes in EVA and MVA are not affected
so much by accounting distortions and inflation than the absolute values.
Dodd and Chen (1996) study the correlation between stock returns and
different profitability measures including EVA, non-adjusted residual income,
ROA, EPS and ROE. In their study ROA explained stock returns best with R
squared of 24,5%. The R squared for other metrics are: EVA 20,2%, residual
income 19,4% and EPS, ROE approximately 5-7%. The writers concluded
that firms adopting EVA might as adopt simple residual income concept, while
residual income correlates with share prices almost as well as its adjusted
version called EVA. The study is based on 566 U.S. companies from 1983-
1992.
In India, the concept of EVA is gaining popularity. Research titled
Economic Value Added - A General Perspective by Asish K Bhattacharyya
& B.V.Phani examines whether EVA is a superior performance measure both
for corporate reporting and for internal governance. It relied on empirical
studies in U.S.A. and other advance economies. It concluded that though EVA
does not provide additional information to investors, it can be adapted as a
corporate philosophy for motivating and educating employees to differentiate
between value creating and value destructing activities. This would lead to
direct all efforts in creating shareholder value. The paper brings to attention
the dangerous trend of reporting EVA casually that might mislead investors.
Chapter-3
Methodology
Study type
The study type is analytical, quantitative and
historical.
Analytical as facts and existing information is used for the analysis.
Quantitative as EVA is calculated and the variables are expressed in
measurable terms.
Historical as the historical information is used for analysis and interpretation.
Study population
Population includes all the domestic and foreign companies.
Sampling frame
Sampling frame includes all those companies that are listed in the stock
exchange.
Sampling technique
Non-probabilistic sampling is used because only particular units are selected
from the sampling frame. Such a selection is undertaken as these units
represent the population in a better way. The companies listed in the stock
exchange are considered since the market prices can be obtained. The
companies in the Sensex are chosen because it is an ideal index and it is a
good proxy for the whole market. Also it is a barometer that indicates the state
and health of the economy.
Sample Profile
Sample includes 24 companies in the BSE Sensex (for which relevant data
was available), for a period of 10 years starting from FY 94-95 to FY 2003-04.
The following are the sample 24 companies:
1. Associated Cement Companies Ltd.
2. Bajaj Auto
3. Bharat Heavy Electricals Ltd.
4. Cipla Ltd.
5. Dr. Reddy’s Laboratories Ltd.
6. Grasim Industries Ltd.
7. Gujarat Ambuja Cements Ltd.
8. Hero Honda Motors
9. Hindalco
10. Hindustan Lever Ltd.
11. Hindustan Petroleum Corporation Ltd.
12. Housing Development Finance Co,
13. ITC Ltd.
14. Infosys Technologies Ltd.
15. Larsen & Tourbro Ltd.
16. Ranbaxy Laboratories Ltd.
17. Reliance Industries
18. Reliance Energy
19. Satyam Computers
20. Tata Iron and Steel Co. Ltd.
21. Tata Motors
22. Tata Power
23. Wipro Ltd.
24. Zee Telefilms
Data gathering procedure and instrumentation
Data:
Historical share prices of the sample companies.
Index values of BSE Sensex
Data Source: Historical share prices of the sample companies and the index
points for the period has been taken from the database of Capital Market
Publishers (India) Ltd., Capitaline 2000. Financial statements of the sample
companies have also been taken from the same source.
Hypothesis 1
H0: There is no significant relationship between EVA and Share prices.
H1: There is significant relationship between EVA and Share prices.
Hypothesis 2
H0: EVA is not a strong factor influencing the share prices as compared to
The first hypothesis is tested using linear regression tool, simple co-efficient of
correlation, co-efficient of determination, t statistic and F statistic.
The second hypothesis is tested using multiple regression tool, multiple co-
efficient of correlation, co-efficient of determination, t statistic and F statistic.
Simple Regression
Y=a+bx
Where,
Y is the dependant variable – market price of shares
a is the constant
x is the independent variable EVA
b is the coefficient of the independent variable
Multiple Regression
Y=a+b1x1+b2x2+b3x3 +b4x4
Where,
Y is the dependant variable – market price of shares
a is the constant
xi are the independent variables – performance metrics like NPR, RONW,
EPS and EVA
bi are the coefficient of the independent variables
Method adopted to calculate EVA is as follows
3. Invested Capital is the total long term funds and includes equity
shares and the total debt as at the end of the year.
Explanation
profit and loss account. Any item capitalized and carried forward to the
balance sheet instead of being shown as an expense in the profit &
loss account will increase the net operating income. At the same time
inclusion of the item in the balance sheet will also increase the capital
employed. However, the increase in the capital charges as a result is
always much less than the increase in the net operating income as it is
factored by cost of capital. Thus accounting ambiguities can be used in
increasing the EVA.
Under the operating approach of capital employed calculation, different
depreciation policies (SLM and WDV here) will yield two different
values. In the calculations above the effect of changing the
depreciation policy on capital employed is shown.
As EVA does not measure cash flows and uses accounting measures
Table No. 1
Market price, NPR, RONW, EPS and EVA for the 24 companies for the year
2003-2004.
Market
Company Name NPR RONW EPS EVA
Price
Associated cement
202.9 5.15 16.48 10.78 133.0363
companies ltd
Bajaj auto 809.975 13.43 21.1 69.09 532.4924
Bhel 425.925 8.88 15.58 26.11 347.6986
Cipla ltd. 192.47 15.53 26.51 49.22 245.8825
Dr.Reddy's laboratories ltd. 1137.13 16.27 14.7 36.37 182.2263
Grasim industries ltd. 778.2 12.71 23.7 83.21 112.8462
Gujarat ambuja cements ltd. 270.78 14.61 18.51 17.75 221.691
Herohonda motors 490.2 27.67 26.46 32.81 1008.065
Hindalco industries 360.525 11.16 65.11 33.91 659.0971
Hindustan Lever ltd. 1014.13 12.78 12.86 88.6 505.744
Hindustan Petroleum Corp.
160.9 15.99 61.14 6.35 1642.06
ltd
Housing Development
400.68 3.29 26.4 53.36 1485.427
Finance co
I T C ltd 1104.68 27.76 44.83 68.82 1021.574
Infosys technologies ltd 901.625 13.48 27.34 61.75 1265.878
Larsen & Loubro ltd. 395.55 5.38 16.99 40.77 401.1886
Ranbaxy laboratories ltd. 1073.675 21.42 37.91 40.66 539.836
Reliance energy 432.05 9.17 17.39 36.31 3257.88
Reliance industries 511.3 10.46 10.61 20.43 45.79024
Satyam computers 260.48 21.87 23.57 17.06 359.9342
Tata Iron and Steel co. Ltd. 490.025 5.34 26.2 21.93 631.3833
Tata motors 268.075 12.38 10.78 25.72 258.0984
Tata power 187.185 14.65 45.36 46.02 1526.184
Wipro ltd. 436.78 17.63 26.76 35.59 662.4929
Zee telefilms 117.15 21.41 3.86 2.66 -5.90491
Table No. 2
Market price, NPR, RONW, EPS and EVA for 24 companies for the year
2002-2003.
Market
Company Name NPR RONW EPS EVA
Price
Associated cement companies ltd 148.95 2.09 6.67 5.75 39.18706
Tata Iron and Steel co. Ltd. 144.6 2.84 11.86 8.87 246.1611
Market
Company Name Price NPR RONW EPS EVA
Associated cement companies ltd 137.98 4.59 13.77 7.63 72.81514
Bajaj auto 355.88 10.58 15.94 51.5 363.4351
Bhel 150.63 7.94 14.28 19.12 238.4659
Cipla ltd. 211.07 16.97 29.51 39.2 187.8532
Dr.Reddy's laboratories ltd. 729.09 29.36 45.71 59.56 170.2494
Grasim industries ltd. 291.9 7.96 13.95 33.05 339.4159
Gujarat ambuja cements ltd. 193.73 11.79 11.92 12.02 120.0262
Herohonda motors 317.02 21.48 22.86 47.66 736.014
Hindalco industries 256.65 10.37 70.41 22.67 425.0116
Hindustan Lever ltd. 709.75 25.98 15.31 92.13 386.9769
Hindustan Petroleum Corp. ltd 208.33 13.96 59.35 7.19 1474.825
Housing Development Finance co 211 1.77 12.73 23.26 555.5485
I T C ltd 912.97 26.44 38.78 142.76 686.5728
Infosys technologies ltd 728.03 12.09 30.43 48.48 937.338
Larsen & Loubro ltd. 212.2 4.25 9.54 13.95 196.6521
Ranbaxy laboratories ltd. 358.28 10.24 13.73 21.74 -15.598
Reliance energy 305.18 7.14 17.63 30.78 2116.849
Reliance industries 193.3 10.5 10.75 20.24 134.2242
Satyam computers 220.85 25.95 32.76 14.24 179.4928
Tata Iron and Steel co. Ltd. 102.73 -0.1 -0.29 0 15.81908
Tata motors 122.03 8.53 8.02 25.68 357.9784
Tata power 68.2 4.59 8.47 5.51 93.91668
Wipro ltd. 459.22 24.91 39.29 37.26 715.3063
Zee telefilms 124.275 23.93 2.41 2.36 -126.336
Table No. 4
Market price, NPR, RONW, EPS and EVA for the sample companies for the
year 2000-2001.
Market
Company Name Price NPR RONW EPS EVA
Tata Iron and Steel co. Ltd. 106.15 -6.31 -14.28 0 -654.301
Market
Company Name Price NPR RONW EPS EVA
Tata Iron and Steel co. Ltd. 218.7 -2.15 -4.98 2.23 -39.4298
Market
Company Name Price NPR RONW EPS EVA
Associated cement companies ltd 105.92 2.48 6.41 39.89 -7.21773
Bajaj auto 584 15.33 22.43 44.39 421.9145
Tata Iron and Steel co. Ltd. 207.15 -0.15 -0.26 3.48 -89.7714
Tata motors 96.9 14.59 10.37 14 113.4555
Market
Company Name Price NPR RONW EPS EVA
Tata Iron and Steel co. Ltd. 344 4.11 7.96 10.97 118.7025
Market
Company Name Price NPR RONW EPS EVA
Associated cement companies ltd 144.38 3.12 7.9 53.21 18.59599
Tata Iron and Steel co. Ltd. 426.88 7.7 25.15 29.01 605.5374
Tata motors 158.88 10.02 8.87 9.91 65.96369
Tata power 131.52 8.31 13.68 12.32 267.8789
Market
Company Name Price NPR RONW EPS EVA
Tata Iron and Steel co. Ltd. 356.5 6.85 27.63 21.92 432.8217
Market
Company Name Price NPR RONW EPS EVA
Associated cement companies ltd 215.35 6.99 28.72 180.13 105.8612
Tata Iron and Steel co. Ltd. 330.69 5.69 28.27 23.29 273.3892
Tata motors 159.75 11.61 14.04 11.03 62.22149
Tata power 169.6 6.08 10.79 8.35 177.4811
Model 1
Y=a+bx
Y is the Market Price
X is the EVA
a is the constant
b is the co-efficient
Table No. 11
Co-efficient of regression, t statistic, Adjusted R2 and F values from the year
1994-2004.
Years a b Adjusted R2 F
96.183 0.096
2003-04 -0.044 0.036
(5.52) (0.19)
338.08 0.00107
2002-03 -0.045 0
(5.40) (0.01)
267.806 0.111
2001-02 0.017 1.409
(4.36) (1.19)
365.55 0.152
2000-01 -0.013 0.709
(3.35) (0.84)
549.473 -0.179
1999-2000 -0.016 0.628
(4.27) (0.79)
172.865 0.221
98-99 0.067 2.64
(3.42) (1.63)
134.273 0.371
97-98 0.146 4.944
(2.42) (2.22)*
130.807 0.511
96-97 0.123 4.215
(1.72) (2.05)*
90.062 0.455
95-96 0.188 6.339
(1.81) (2.52)*
85.07 0.941
94-95 0.327 12.167
(1.98) (3.49)*
In the recent years the Fcal < Ftab, so the null hypothesis is accepted.
But for the years 94-98 the Fcal > Ftab, indicating that there is relationship.
The R2 values for the years 94-98 are 0.146, 0.123, 0.188 and 0.327
respectively. This indicates that the relationship is not very significant, and
also not consistent.
Y=a+b1x1+b2x2+b3x3
Y is Market price
X1 is NPR
X2 is RONW
X3 is EPS
a is the constant
bi are the co-efficients
Table No. 12
Co-efficient of regression, t statistic, Adjusted R2 and F values from the year
1994-2004.
Adjusted
Years a b1 b2 b3 2 F
R
35.689 12.49 -2.196 9.403
2003-04 0.432 6.83
(0.22) (1.57) (0.64) (4.23)*
49.179 10.096 -0.628 5.142
2002-03 0.669 16.489
(0.74) (2.14)* (0.32) (5.15)*
55.935 2.931 1.688 5.642
2001-02 0.778 27.848
(1.28) (0.90) (1.20) (6.57)*
-82.164 12.399 4.483 8.704
2000-01 0.674 16.869
(0.89) (1.96) (1.45) (4.13)*
1999- 157.651 -7.002 11.561 5.183
0.19 2.794
2000 (1.07) (0.64) (2.05)* (0.94)
216.579 3.061 -0.887 0.13
98-99 -0.132 0.107
(2.58)* (0.56) (0.32) (0.16)
234.042 4.257 -3.35 0.284
97-98 -0.079 0.436
(2.16)* (0.65) (0.91) (0.27)
337.003 2.08 -5.967 0.519
96-97 -0.072 0.483
(2.07)* (0.28) (1.09) (0.33)
278.062 0.719 -5.094 0.498
95-96 -0.08 0.43
(1.75) (0.15) (0.88) (0.74)
254.059 -2.024 -1.76 0.543
94-95 -0.094 0.341
(2.05)* (0.56) (0.37) (0.63)
The t values for EPS are more than t values for NPR and RONW. Also
in the recent 4 years from 2000-2004, the t values for EPS is highly
significant.
The R2 values for the years 1999-2004 are positive. This indicates that
the relationship is very significant.
This clearly shows that in India, investors’ decision is based on the EPS.
Y=a+b1x1+b2x2+b3x3 +b4x4
Y is Market price
X1 is NPR
X2 is RONW
X3 is EPS
X4 is EVA
a is the constant
bi are the co-efficients
Table No. 13
Co-efficient of regression, t statistic, Adjusted R2 and F values from the year
1994-2004.
Adjusted
Years a b1 b2 b3 b4 2 F
R
46.371 12.029 -1.676 9.479 -0.0289
2003-04 0.406 4.936
(0.28) (1.46) (0.44) (4.15)* (0.37)
59.121 9.478 -0.384 5.235 -0.02303
2002-03 0.656 11.971
(0.84) (1.91) (0.19) (5.07)* (0.51)
50.37 3.333 1.417 5.551 0.02128
2001-02 0.768 20.063
(1.08) (0.95) (0.90) (6.14)* (0.41)
-73.309 11.327 6.489 9.089 -0.136
2000-01 0.678 13.087
(0.79) (1.78) (1.82) (4.28)* (1.10)
1999- 235.442 -6.13 12.711 5.893 -0.347
0.264 3.064
2000 (1.60) (0.59) (2.34)* (1.12) (1.74)
161.287 4.682 -1.702 -0.451 0.256
98-99 -0.031 0.83
(1.87) (0.88) (0.63) (0.55) (1.77)
152.345 5.905 -4.252 -0.128 0.401
97-98 0.112 1.723
(1.46) (0.99) (1.27) (0.13) (2.30)*
188.524 4.832 -5.401 0.0071 0.517
96-97 0.057 1.346
(1.10) (0.69) (1.05) (0.01) (1.93)
83.196 1.623 -1.267 0.417 0.444
95-96 0.092 1.583
(0.49) (0.37) (0.23) (0.68) (2.19)*
84.883 0.268 -0.349 0.208 0.932
94-95 0.224 2.662
(0.72) (0.09) (0.09) (0.28) (3.03)*
The R2 values for all the years, excepting 1998-1999 are positive. This
indicates that the relationship is very significant.
Chapter-5
DISCUSSIONS
Creating shareholder value is a fundamental requirement for all the
companies. Therefore, most of the leading companies adopt the mantra of
shareholder value to meet the increasing expectations of the share holders.
To see whether this relationship holds good the study has been
undertaken by taking 24 companies which are listed in BSE and are a part of
SENSEX, for a period of 10 years. The market prices of the shares are
compared with the 4 performance measures - NPR, RONW, EPS and EVA, to
analyse the extent of influence of each on the share prices.
Text Books
Websites
www.investopedia.com
www.valuebasedmanagement.net
www.evanomics.com
www.rbi.org.in
www.bseindia.com
www.indiainfoline.com
References
Articles of ICFAI
(The Institute of Chartered Financial Analysts of India)
Others
o Database of Capital Market Publishers (India) Ltd., Capitaline 2000