FREE online courses on Financial Management and Creating Value - Chapter 2
- Monitoring Value-Creation
One missing link in this process known as Value Based
Management is some form of measurement. It has been said that in order to manage
something, you need to measure it. When it comes to measuring value-creation, we
need to focus on what kind of return management generates from the capital
invested. Comparing rates of return to the cost of capital can help us
understand how we are doing. For publicly traded companies, one obvious place to
look is the stock price. The total outstanding shares of stock multiplied by the
stock price is the market value of the company. We can extend this concept of
measuring value by measuring Market Value Added or MVA.
Market Value Added (MVA) is the difference between the
capital that has been invested and the market value of the capital. MVA is the
assessment within the marketplace on what the net present value is for all
investments made by the company.
MVA = Market Value of Debt + Market Value of Equity - Total
Adjusted Capital
The market value of debt is not always readily available and
therefore, some companies focus on the equity portion only. Additionally, the
total amount of capital originally invested is easily distorted by various
accounting entries. We are trying to compare all of the cash that has been
invested into the business with the market value of all investments. The
incremental value that has been added over time is MVA.
MVA is also used as a way of benchmarking market performance
between companies. In order to have a comparable MVA, a standardized MVA is
calculated by dividing the change in MVA by the adjusted equity value at the
beginning of the year.
Standardized MVA = Change in MVA for the Year / Adjusted
Equity at Beginning of Year
Delmar Corporation has 100,000 shares of stock outstanding
with a market price of $ 22.50 per share. Delmar has reviewed the book values of
equity and adjusted back to a cash equivalent value of $ 2,145,000. In arriving
at the $ 2,145,000, Delmar reversed out the negative affects on equity, such as
extra ordinary losses. Last year Delmar had a Market Value Added of $ 75,000.
Market Value of Equity = 100,000 x $ 22.50Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â $
2,250,000
Total Adjusted Capital
                                            Â
$ 2,145,000
                  Difference is Market Value
Added                  105,000
                  Last Year's MVA was
                                              75,000
                  Change in MVA                                            30,000
Calculate Standardized MVA: $ 30,000 / $ 2,145,000 =Â Â Â Â Â Â Â Â Â 1.4%Â Â Â Â Â
In his book Quest for Value, G. Bennett Stewart III describes
MVA as: "the value a company has created in excess of the resources already
committed to the enterprise. In theory, MVA represents the net present value of
all past and projected capital projects."
