Economic Value Added "EVA"

Economic Value Added or EVA is a tool for gauging the real economic
performance of a business and its ability to create shareholder value. EVA
provides a means for coupling the two fundamental drivers of economic or
share holder value– operating earnings and capital efficiency. The
benefits of EVA are discussed in greater detail in the Fall 2005 issue of
InSight.

The EVA Example worksheet details the calculation of EVA over

five years for a middle-market manufacturing company operating
in a capital intensive industry.

The EVA Template worksheet provides a simple template for the

calculation of EVA from annual financial statement inputs provided
by the user.

Introduction EVA is a trademark of Stern Stewart Co

 Economic Value Added Example

Subject Company: XYZ Consolidated

XYZ Consolidated is an example of a manufacturing company operating in a capital

intensive industry. Over five years, revenue grew at a compound annual growth
rate (CAGR) of 9.6%. At the same time, operating earnings expanded at a CAGR of
9.0%. The company also invested approximately 86¢ in new fixed assets for each
$1.00 of incremental sales.

From an income statement perspective, this company is a successful middle-market

business, even though the company's EVA was negative in two of the five years.
On a cumulative present value basis, the firm generated positive EVA over the full
period and, therefore, built economic or shareholder value in excess of the required
return on invested capital.
The economic value calculation is based upon the company's historical annual
Profit & Loss Statements and Balance Sheets summarized on pages 2 & 3. Net
operating profit after tax ("NOPAT"), on page 4, is determined by adjusting GAAP
operating earnings to reflect any difference between book and economic
depreciation, the recognition of R&D expenditures over the period that they are
expected to benefit the business, and the capitalization of operating lease
obligations. Total capital employed in the business, on page 5, is determined by
adjusting book value of interest bearing debt and equity to include capitalized R&D
expenditures, any excess book depreciation in prior periods, all previously
amortized goodwill, and the present value of future operating lease obligations.
Different or additional adjustments may be appropriate depending on the
circumstances of the subject business.
The conclusions regarding the company's ability to generate economic value added
are presented on page 6.

EVA is a trademark of Stern Stewart & Co

EVA Example -2-

 EVA is a trademark of Stern Stewart & Co

Summary Profit and Loss Statement

Year 1 2 3 4 5

Sales 130,984 124,530 134,801 152,327 181,173

Sales Growth 14.4% -4.9% 8.2% 13.0% 10.0%

Cost of Sales 95,749 93,425 100,293 111,953 137,567

Gross Profit 35,235 31,105 34,509 40,374 43,606
Gross Margin 26.9% 25.0% 25.6% 26.5% 24.1%

S, G & A 15,256 16,258 16,173 17,487 19,291

Depreciation & Amortization 9,602 9,225 9,016 8,995 8,322
Operating Profit 10,377 5,622 9,320 13,892 15,993
Operating Margin 7.9% 4.5% 6.9% 9.1% 8.8%

Interest Expense 1,813 1,823 1,802 1,869 2,064

Other (Income) Expense 150 (65) (39) 215 1,395
Pre-tax Profit 8,414 3,863 7,557 11,808 12,534

Tax Expense 2,861 1,314 2,569 4,015 4,262

Net Profit 5,554 2,550 4,988 7,794 8,272
Net Profit Margin 4.2% 2.0% 3.7% 5.1% 4.6%

EBITDA 19,830 14,912 18,375 22,672 22,920

EBITDA Margin 15.1% 12.0% 13.6% 14.9% 12.7%

EVA Example -3-

 XYZ Consolidated
Unadjusted Annual Balance Sheet
($ in Thousands)

Summary Balance Sheet

Year 1 2 3 4 5

Cash 7,084 9,208 10,071 14,428 5,190

Trading Assets 14,072 12,472 13,262 18,028 19,358
Total Current Assets 21,156 21,681 23,333 32,457 24,548

Property & Equipment 95,430 103,596 113,045 122,537 136,762

Less: Accumulated Depreciation (45,169) (54,180) (60,283) (68,120) (72,286)
Net Property & Equipment 50,261 49,416 52,763 54,417 64,476

Deposits an Other Assets 1,074 1,964 1,472 1,398 3,623

Goodwill - - - - -

Total Assets 72,491 73,061 77,568 88,272 92,647

Bank Credit Line - - - - -

Accounts Payable 3,892 3,574 3,846 5,950 4,759
Other Accrued Liabilities 11,195 12,093 12,805 19,056 14,706
Current Portion of Long-term Debt 1,177 1,198 62 3,679 3,638
Total Current Liabilities 16,263 16,865 16,713 28,685 23,103

Long Term Debt, less current portion 34,072 33,215 33,077 29,395 25,408
Other LT Liabilities 724 929 1,065 1,522 1,865

Net Worth 21,432 22,052 26,712 28,670 42,270

Total Liabilities & Net Worth 72,491 73,061 77,568 88,272 92,647

EVA Example -4-

 XYZ Consolidated Assumptions in red bold
Annual EVA Summary
($ in Thousands)

Net Operating Profit After Taxes

Year 1 2 3 4 5 Comments

Operating Profit 10,377 5,622 9,320 13,892 15,993 Net of depreciation and amortization

Adjustments:
Depreciation - - - - - No adjustment made - book and
economic depreciation are reasonably
Other Expense (150) 65 39 (215) (1,395) equivalent
LIFO Adjustment - - - 1,041 (376) Change in the LIFO Reserve
Research & Development 335 (150) (89) 18 (80) Difference between expensing all R&D
and capitalizing and amortizing over 5
Operating Lease Expense 3,257 3,224 3,412 3,471 3,218 years
Add back annual rents and operating
Miscellaneous - - - - - lease payments

Taxes (4,699) (2,979) (4,312) (6,190) (5,902) Taxes payable on adjusted operating
profits excluding the tax shield from
interest expense.

NOPAT 9,121 5,782 8,370 12,017 11,458

EVA Example -5-

 XYZ Consolidated Assumptions in red bold
Annual EVA Summary
($ in Thousands)

Total Invested Capital and Cost of Capital

Year 1 2 3 4 5 Comments

Capital Employed:
Debt 35,249 34,413 33,139 33,074 29,046 All interest bearing debt
Equity 21,432 22,052 26,712 28,670 36,942 Book value of equity
Book Value of Capital 56,681 56,465 59,851 61,744 65,989

Adjustments:
Capitalized R&D 6,901 6,751 6,662 6,680 6,600 Total R&D expenditures, net of
Depreciation - - - - - amortization
No adjustment necessary
Goodwill - - - - - Add back all cumulative goodwill
Present Value of Operating Leases 10,558 12,645 11,678 9,700 7,400 amortization
Add present value of operating leases
discounted at Kd.

Total Adjusted Capital 74,140 75,860 78,191 78,123 79,988

Cost of Capital: Pre-Tax After-Tax Weighting

Debt (Kd) 6.5% 4.3% 55% Average over 5 years, should be based
on the capitalization norm within the
Equity 20.0% 20.0% 45%
industry
Weighted Average (Kw) 12.6% 11.4%
Tax Rate 34.0%

EVA Example -6-

 XYZ Consolidated
Annual EVA Summary
($ in Thousands)

Economic Value Added

Year 1 2 3 4 5

NOPAT 9,121 5,782 8,370 12,017 11,458

Capital Cost 8,441 8,636 8,902 8,894 9,106

Annual EVA 681 (2,854) (532) 3,123 2,351

Current Value of Cumulative EVA 442 (1,623) (2,052) 751 3,103

NOPAT Return on Adjusted Capital 12.3% 7.6% 10.7% 15.4% 14.3%

Return Hurdle (cost of capital) 11.4% 11.4% 11.4% 11.4% 11.4%

Value Added / -Shortfall 0.9% -3.8% -0.7% 4.0% 2.9%

Other Performance Measures

EBIT 10,228 5,687 9,359 13,677 14,598

EBITDA 19,979 14,847 18,336 22,887 24,315

Sales Growth 14.4% -4.9% 8.2% 13.0% 18.9%

Operating Earnings Growth 50.3% -45.8% 65.8% 49.1% 15.1%

Net Profit Growth -21.4% -54.1% 95.6% 56.3% 6.1%

Operating Margin 7.9% 4.5% 6.9% 9.1% 8.8%

Net Profit Margin 4.2% 2.0% 3.7% 5.1% 4.6%

EBITDA Margin 15.1% 12.0% 13.6% 14.9% 12.7%

Return on Equity(ROE) 25.9% 11.6% 18.7% 27.2% 19.6%

Return on Net Assets (RONA) 9.7% 4.4% 8.2% 12.3% 11.3%

EVA Example -7-

 Sales / Gross Fixed Assets 1.4 1.2 1.2 1.2 1.3

EVA Example -8-

 EVA Template
Subject Company:

This worksheet is intended as a simple template for calculating economic value added (EVA) from
annual financial statement inputs provided by the user. Depending on the circumstances of the
subject company, it may not provide all of the adjustments that would be appropriate for a
technically precise EVA calculation. A more detailed explanation of the calculation of EVA and the
underlying financial theory can be found in "The Quest for Value" by G. Bennett Stewart III,
published by HarperBusiness.

EVA is a trademark of Stern Stewart & Co.

Unadjusted Annual Performance Data Insert assumptions

($ in Thousands)

Summary Profit and Loss Statement

Year 1 2 3 4 5

Sales 100,000 110,000 121,000 133,100 146,410

Sales Growth -12.7% 10.0% 10.0% 10.0% 10.0%

Cost of Sales 75,000 82,500 90,750 99,825 109,808

Gross Profit 25,000 27,500 30,250 33,275 36,603
Gross Margin 25.0% 25.0% 25.0% 25.0% 25.0%

S, G & A 12,000 13,200 14,520 15,972 17,569

Depreciation & Amortization 8,500 9,000 9,000 9,000 9,000
Operating Profit 4,500 5,300 6,730 8,303 10,033
Operating Margin 4.5% 4.8% 5.6% 6.2% 6.9%

Interest Expense 1,813 1,823 1,802 1,869 2,064

Other (Income) Expense 150 (65) (39) 215 1,395
Pre-tax Profit 2,537 3,541 4,967 6,219 6,574

Tax Expense 863 1,204 1,689 2,114 2,235

Net Profit 1,674 2,337 3,278 4,105 4,339
Net Profit Margin 1.7% 2.1% 2.7% 3.1% 3.0%

EBITDA 12,850 14,365 15,769 17,088 17,638

EVA Template -9-

 EBITDA Margin 12.9% 13.1% 13.0% 12.8% 12.0%

EVA Template - 10 -
 - Insert assumptions
Unadjusted Annual Balance Sheet
($ in Thousands)

Summary Financial Position

Year 1 2 3 4 5

Cash 7,300 9,000 10,100 14,700 5,400

Trading Assets 14,000 12,500 13,000 18,000 19,300
Total Current Assets 21,300 21,500 23,100 32,700 24,700

Property & Equipment 95,000 103,500 113,000 122,000 136,700

Less: Accumulated Depreciation (45,200) (54,200) (60,300) (68,100) (72,300)
Net Property & Equipment 49,800 49,300 52,700 53,900 64,400

Deposits an Other Assets 1,000 2,000 1,500 1,400 3,600

Goodwill - - - - -

Total Assets 72,100 72,800 77,300 88,000 92,700

Bank Credit Line - - - - -

Accounts Payable 3,900 3,700 3,800 5,950 4,750
Other Accrued Liabilities 11,200 12,100 12,800 19,000 14,700
Current Portion of Long-term Debt 1,200 1,200 50 3,700 3,600
Total Current Liabilities 16,300 17,000 16,650 28,650 23,050

Long Term Debt, less current portion 34,100 32,900 32,850 29,150 25,550
Other LT Liabilities 700 900 1,100 1,500 1,900

Net Worth 21,000 22,000 26,700 28,700 42,200

Total Liabilities & Net Worth 72,100 72,800 77,300 88,000 92,700

EVA Template - 11 -
 -
Annual EVA Summary
($ in Thousands)

Net Operating Profit After Taxes

Year 1 2 3 4 5 Comments

Operating Profit 4,500 5,300 6,730 8,303 10,033 Net of depreciation and amortization

Adjustments:
Depreciation - - - - - Adjust for the difference between book
and economic depreciation
Other Expense (Income) (150) 65 39 (215) (1,395) Deduct other expenses
LIFO Adjustment - - - 1,041 (376) Change in the LIFO Reserve
Research & Development 335 (150) (89) 18 (80) Add back difference between current
period R&D expense and amortization of
capitalized R&D
Operating Lease Expense 3,257 3,224 3,412 3,471 3,218 Add back annual rents and operating
Miscellaneous - - - - - lease payments

Taxes (2,700) (2,869) (3,431) (4,290) (3,876) Deduct taxes payable on adjusted
operating profits excluding the tax shield
from interest expense.

NOPAT 5,242 5,569 6,660 8,328 7,524

EVA Template - 12 -
 - Insert assumptions

Annual EVA Summary

($ in Thousands)

Total Invested Capital and Cost of Capital

Year 1 2 3 4 5 Comments

Capital Employed:
Debt 35,300 34,100 32,900 32,850 29,150 All interest bearing debt
Equity 21,000 22,000 26,700 28,700 33,039 Book value of equity
Book Value of Capital 56,300 56,100 59,600 61,550 62,189

Adjustments:
Capitalized R&D 6,901 6,751 6,662 6,680 6,600 Add historical R&D expenditures, net of
amortization. Amortize over period that
value is expected to be derived
Depreciation - - - - - Add back excess book depreciation in
Goodwill - - - - - prior periods
Add back all cumulative goodwill
Present Value of Operating Leases 10,558 12,645 11,678 9,700 7,400 amortization
Add present value of operating leases
discounted at Kd.

Total Adjusted Capital 73,759 75,495 77,940 77,929 76,188

Cost of Capital: Pre-Tax After-Tax Weighting

Debt (Kd) 6.5% 4.3% 55%

Equity 20.0% 20.0% 45%
Weighted Average (Kw) 12.6% 11.4% Kw should be weighted based upon the
capitalization norm for the industry
Tax Rate 34.0%

EVA Template - 13 -
 -
Annual EVA Summary
($ in Thousands)

Economic Value Added

Year 1 2 3 4 5

NOPAT 5,242 5,569 6,660 8,328 7,524

Capital Cost 8,379 8,576 8,854 8,852 8,655

Annual EVA (3,137) (3,006) (2,193) (525) (1,130)

Current Value of Cumulative EVA (2,040) (4,217) (5,985) (6,457) (7,587)

NOPAT Return on Adjusted Capital 7.1% 7.4% 8.5% 10.7% 9.9%

Return Hurdle (cost of capital) 11.4% 11.4% 11.4% 11.4% 11.4%

Value Added (-Shortfall) -4.3% -4.0% -2.8% -0.7% -1.5%

Other Performance Measures

EBIT 4,350 5,365 6,769 8,088 8,638

EBITDA 13,000 14,300 15,730 17,303 19,033

Sales Growth -12.7% 10.0% 10.0% 10.0% 10.0%

Operating Earnings Growth -34.8% 17.8% 27.0% 23.4% 20.8%

Net Earnings Growth -76.3% 39.6% 40.2% 25.2% 5.7%

Operating Margin 4.5% 4.8% 5.6% 6.2% 6.9%

Net Profit Margin 1.7% 2.1% 2.7% 3.1% 3.0%

EBITDA Margin 12.9% 13.1% 13.0% 12.8% 12.0%

Return on Equity (ROE) 8.0% 10.6% 12.3% 14.3% 10.3%

Return on Net Assets (RONA) 2.9% 4.1% 5.4% 6.5% 5.9%

Sales / Gross Fixed Assets 1.1 1.1 1.1 1.1 1.1

EVA Template - 14 -