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EVA: SWOT analysis Essay

EVA: SWOT analysis

A registered trade mark symbol that calculates the economic profit by a specific method of the Stern Stewart & Co. is referred to as Economic Value Added or EVA. It is necessary for any business to earn the profit in such a way that, besides the coverage of the costs associated with the capital, it should be able to create a surplus for the growth of the business. In other words, EVA or the economic value added is, earning the profits over or above the cost of the capital. There exist many traditional methods to measure the corporate performance.

EVA is a new measure of corporate surplus and it should be shared between the management, employees and share holders. In contrast to the traditional profit that is available to the share holders, EVA is a clear surplus and the companies use EVA as an indicator of performance. EVA is also used as a basis to the compensation of the executive. To derive the surplus, cost of the capital is deducted from the profit after the tax and before the interest. EVA= NOPAT- WACC X Capital employed NOPAT is the net operating profit before interest and after tax

WACC is weighted average cost

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of the capital. Capital employed = net block + trading investment + net current assets. There is no need to adopt subjective assumption when profit and cost of the capital are identified. Capital Assets Pricing Model or CAPM is the basis for the derivation of the cost of equity, and CAPM is traditionally used by the founders of the EVA. EVA is a powerful tool for the measurement of the performance. It is an argument that if company is a better performer for its share holders, it can also become a better performer for all of its stakeholders.

SWOT analysis: It is necessary to generate a frame work of strategic alternatives after analyzing the situation. It is the important to analyze the strengths, weaknesses, opportunities and threats as applied to the EVA model in the present situation. Strengths: Companies use EVA not only to evaluate the performance but also use the EVA as a basic thing to determine the incentive pay. There exists a tension between the measure of performance that has a correlation with the wealth of the share holder and the minimum influence on the random fluctuation in the stock market.

The resolution of this tension is difficult with the performance measures which are based on accounting. (Easton. P, Harris. T, and Ohlson. J, 1992). According to Stewart and Bennet (1994), the “EVA is a powerful management tool that has international acceptance as the standard of corporate governance. EVA is the integrated frame work of the financial management and incentive compensation”. The legitimacy of the principles of macroeconomics and the principles of the corporate finance are justified by the EVA.

The EVA helps to focus the energies and resources for the creation of values that are sustainable for the companies, employees, shareholders and the management. Through EVA, it is possible to meet the objectives of the business and it is also possible to create a new corporate culture. It is possible to take decisions efficiently and effectively by analyzing the decisions through the principles of EVA. Through EVA it is possible to meet directly the interests of the management and the shareholders. (Rice. V. A, 1996).

EVA is a trendsetter in the managerial performance of the economics of a corporation. Changes in the EVA in a positive way may lead to the reduction of costs, managing the assets of the company in a better way, and in addition to reducing the costs of the capital; it also helps to invest in the projects of NPV in a positive way. (Peters, 2001). Weaknesses: The EVA as a percentage of capital employed indicates a true return of the capital employed, and the EVA was compared to the traditional measures in some studies.

According to these studies the companies give a rosy picture in terms of EPS, ROCE and RONA. The traditional measures do not give a real value of the share holders and measurement of EVA has to be done based on the ideal about the value of the share holder. (Thenmozhi, M, 2000). The missing link between the EVA and improved financials is productivity and it is important to apply EVA properly. The EVA allows the firm to identify whether the return on the capital is outstripping the cost of the capital. (Ray.R, 2001).

Opportunity: The value generating power of an organization is represented by the EVA, and three factors are responsible for computing the EVA. a) adjusted earning before interest after tax b) weighted average cost of the capital c) capital employed The changes in any of these above three factors will lead to a change in the EVA. (Debdas,R,2006). The share holder value of a company is the criteria to measure its performance and a real measure of this is possible only through EVA. (Bennet Stewart, 1991).

A performance measurement model like EVA creates an economic value as it provides an opportunity to revise the policies the company that can improve the performance of its employees through educating and learning about the policies that paves the way for the success of the company. Ultimately it is the shareholder who provides the capital for the investments, acquisitions and the formation of the assets, and the company’s effort to use the best of its efforts to use the capital effectively. EVA helps in achieving this target. Threat:

The EVA is regarded as the most viable alternative that can measure the value of the share holder more accurately and comprehensively than the other available methods. (Bennet Stewart,1991). It is the variant of older residual income concepts, and it is heralded as the ‘the real key to creating wealth’ (Fortune, 1993), ‘a star to sail by’ (The Economist, 1997), ‘the key to making shareholders rich’ and the ‘new winner in the metric wars’ (Martin, 1996). EVA has it wider acceptance as the innovative measure of the performance and is implemented widely in US, Europe and Australia. (Dodd and Chen,1996).

Despite the above propositions, the EVA needs further investigation as the benefits associated with it are limited and weak to support the claim that EVA is beneficial. (Ittner and Larcker, 1998). As has been stated by some researchers that the EVA that is implemented across the organizations is similar, contradictions exist in that there is diversity in the implementation of EVA in different organizations. (Malmi and Ikaheimo, 2003). There is a need for a thorough study of the EVA that examines “the key implementation issues influencing the success or failure of various economic value measures”(Ittner and Larcker, 1998, p.214).

This type of study helps “ in providing a more a more comprehensive understanding of why VBMs value based management tools such as EVA fail, or identify whether there are contingent factors that might explain differences in such practices” (Malmi and Ikaheimo, 2003, p. 249). Introduction: Shell Oil Company, an affiliate of the Royal Dutch Shell Company is an international company of Anglo Dutch origin and is largest of the oil companies of the world. The company is the market leader in the supply of gasoline and it has a 50percent ownership with Saudi Aramco, an oil company owned by the government of Saudi Arabia.

It has 80% holdings with Pecten, an oil exploration firm that performs explorations at various offshore locations. The business of the company was independent in United States with its stocks traded on NYSE. The group head offices have a little role in the American business. Even after its acquisition by the Shell Company in 1984the business of the Shell oil was independent, and the independence was gradually decreased with the interference of the companies in running the business. The company has been issued violation for its infringements in the of the clean air act.

The company has initiated a sustainable energy programme that promotes sustainable energy. Merger and acquisition: The desire of a company to grow vertically and horizontally is fulfilled by the process of mergers and acquisitions in contrast to the organic growth where the development of the company from within is slow and difficult.

It is the strategy of the big companies to search for the targets that have the potential for mergers and acquisitions. A senior person of the company takes decisions, and these decisions are based on the policy of the company whether to diversify or expand by continuously scanning the business world.Mergers and acquisitions make an impact on the organization with changes in the ownership, and in ideology.

References:

Debdas Rakshit. (2006), EVA based performance measurement, A case study of Dabur India Limited Vidyasagar University Journal of Commerce, Vol. 11, pp. 1-21, March 2006 Dodd, J. L. and S. Chen. (1996). “Economic Value Added (EVA). ” Arkansas Business and Economic Review, Vol. 30, No. 4, pp. 1-9. Easton, P. , Harris, T. & Ohlson, J. (1992), “Aggregate Earnings can explain most security returns”, Journal of Accounting and Economic, June – September.

Ittner, C. and Larcker, D. (1998) “Innovation in Performance Measurement: Trends and Research Implications”, Journal of Management Accounting Research, 10, pp. 205-238. Malmi, T. , and Ikaheimo, S. (2003) “Value Based Management practices – Some evidence from the field”, Management Accounting Research, pp. 235-254 Ray, Russ (2001), “Economic Value Added: Theory Evidence, A Missing Link”, Review of Business, Vol. 22, No. 2, Summer 2001. Stewart, G. Bennett (1994), : Fact and Fantasy”, Journal of Applied Corporate Finance, Summer, Vol. 7, No. 2, 1994, pp. 71-84.

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