Background Tepi's Proposal

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CHAPTER I

INTRODUCTION

1.1. Background

Performance measurement is the foundation of business.


Financial measuring tools are many and varied. Business
people tend to focus on financial accounting metrics such as
sales and sales growth, margin, operating profit and operating
profit growth, earnings per share (EPS), market value, return
on equity (ROE), and return on assets (ROA) or cash flow.

Each of these metrics is flawed. Neither sales nor operating


profit accounts for the financial requirements necessary to
achieve them, in terms of either annual expenses or capital
invested. EPS take no account of the fact that equity has a
cost. Market value ignores the capital employed to create it—
invest more, and of course market value rises, without
necessarily creating value. And yet each is popular.¹

Since people manage what they measure, EVA can form


the foundation for a more transparent and accountable
analysis.

The measure should differentiate between financial inputs—


what enters a company over time—and outputs—the value
created. Clearly our choice should not be a driver of value
such as the financial accounting metrics that managers can
influence. Consider instead output, on an annual basis, as
operating profit after tax, with certain adjustments for
intangible and other long-term investments and other
accounting anomalies, and input as the annual rental charge
on the total capital employed, both debt and equity. The rental
charge or required return, known alternatively as the hurdle
rate for investments or the weighthed average cost of capital,
is the true benchmark against which all investments and
management should be measured. This is economic value
added (EVA).²
This measure was devised by Stern Stewart & Co. Economic
value added attempts to capture the true economic profit of a
company. EVA is a proprietary trademark of Stern Stewart and
Company. The history of EVA can be traced back to Stewart’s
(1991) path breaking book “The Quest of Value”.
From it’s official website (www.sternstewart.com) :
In the late 1980’s Stern Stewart & Co.’s management team
developed an alternate approach that would be used also to
provide incentives for the management team. This new
approach offered identical valuations with FCF. We called it
Economic Value Added – EVA®. Thus, now there are two
models to maximize value. There is the FCF model and there is
the EVA® model, the latter converts a firm’s accounting book
value into economic book value, which represents the total
resources invested into the firm by both lenders and
shareholders. The firm’s market value represents the cash
that could be removed from the firm if the firm sold at today’s
price. Under the EVA® framework, it is simply the cash
invested into the firm and the cash that could be taken out of
the firm. If the latter is greater than the former, we could say
that shareholder value has been created.
Economic book value is equal to the accounting book value
adjusted for various accounting anomalies. The EVA®
valuation model is equal to the amount of economic book
value plus the present value of expected future EVA®.
EVA® can be calculated unit by unit throughout a firm, even
down to the shop floor, so that the boards of directors and
senior management can measure value add year-by-year. If
EVA® is growing, value is being created. If EVA® is falling,
value is being destroyed. Furthermore, because EVA® can be
measured throughout an organization in individual operating
units, incentive contracts can be designed to maximize value
at all levels so employees throughout the organization and not
just for senior management can participate in the program.

From the journal “Does Economic Value Added (EVA) Improve


Stock Performance Profitability?” by Robert Ferguson, Joel Rentzler,
and Susana Yu, Journal of Applied Finance, 2005, they stated that :

The consulting firm Stern Stewart characterizes itself as


“specializing in helping client companies in the measurement
and creation of shareholder wealth”. The firm pioneered the
development of its proprietary EVA framework and says, “EVA
is the financial performance measure that comes closer than
any other to capturing the true economic profit of an
enterprise. EVA also is the performance most directly linked to
the creation of shareholder wealth over time. Stern Stewart &
Co. Guides client companies throught the implementation of
complete EVA-based financial management and compensation
system that gives manager superior information—and superior
motication—to make decisions that will create the greatest
shareholder wealth in any publicly owned or private
enterprise.” The firm’s technique for creating shareholder
wealth is to create EVA.³

The primary benefit of EVA is to encourage managers


throughout the firm to acknowledge that shareholder value is
not being created without a positive economic profit. The firm
must earn an amount sufficient to pay for its capital and have
some left over to "add value" over and beyond the returns
available to the shareholder from investing in other
opportunities of similar risk.
From an investment analyst's point of view, the market
value of a business has two components: the capital that
shareholders have invested in the firm and the added value
management has created over and beyond the amount of
invested capital. It is this second component, market value
added (MVA), that measures the actual amount of shareholder
wealth created. Over time, MVA correlates strongly with EVA.

In the past few years, many highly successful organizations


have begun using MVA and EVA as measures of financial
performance. MVA measures managerial effectiveness since
an organization's inception, and EVA measures managerial
effectiveness during a given year. As an indicator of corporate
effectiveness in maximizing shareholder wealth, MVA is most
appropriate for investor-owned firms. Though it can be applied
to investor-owned organizations, EVA also can be used and
measures how well managers are maximizing the economic
value of the organization's capital. Once healthcare financial
managers understand the rationale and potential uses of
these measures, they may find them more helpful for
measuring an organization's economic profit than accounting
profitability measures, which account for the cost of debt but
not the cost of equity.⁴
Writer understand that the fundamental objective of any
business enterprise is to create wealth for its owners.
However, most business seems to focus on just profit and not
the value creation. Therefore, writer would like to understand
about this topic more deeply. And since financial accounting
metrics are flawed and not the most appropriate tool to
measure value creation as well as shareholders wealth, writer
would be using EVA and MVA as the measurement tool,
because EVA and MVA can provide a better picture in
measuring financial performance and value creation of a
company.

In order to understand this topic, writer will use a sample of


one public company who specialize in advertising, PT. XYZ It is
a service-based company with main service of advertising.
Writer choose this company because it is one of the top
company in Indonesia and it will be a useful information for
the company and public in which they serve. Also, writer
would like to apply EVA and MVA method to non-
manufacturing company because EVA and MVA mostly
associated with manufacturing companies and not service-
based companies. Writer hopes this thesis would be useful for
company to have a better understanding about their financial
performance and value creation ability. Writer also hopes this
thesis would be useful for shareholders to have a better
understanding whether their investment has been creating
values or not.

1.2. Problem Formulation


Based on the background and the title of this thesis, “Using
EVA and MVA Method to Evaluate Financial Performance of PT.
XYZ in Relation with Value Creation and Shareholders Wealth
from Year 2005 to 2009” the problem formulation in this thesis
is to answer this question :
1) What PT Fortune Indonesia Tbk. financial performance is
from 2005 to 2009 when it is evaluated using EVA and MVA
method?
2) Has PT. XYZ financial performance from 2005 to 2009
created values for the shareholders or not?
3) What PT Fortune Indonesia Tbk. shareholders wealth is
when it is evaluated using MVA for year 2005 to 2009?

1.3. Purpose of the Research


The purpose of this research is :
1) To have a better understanding about the company’s
financial performance when it is evaluted using EVA
method
2) To have a better understanding about whether the
company has created values for the shareholders or not

1.4. Advantages of the Research


There are two kind of advantages on this research :
1.4.1 Academic Advantage:
The academic advantage of this thesis is to test and evaluate
the writer’s ability and understanding about managerial
accounting, especially in EVA method. Also, this thesis is as an
evaluation and implementation material of accounting science
about company’s performance evaluation using EVA method.
1.4.2. Non-Academic Advantage:
The non-academic advantage of this thesis is to give a better
picture of the company performance about its financial
condition with hopes that company can increase its
performance and creates more values for the shareholders

1.5. Research Methodology


1.5.1. Sources of Data
1) Primary Data
Writer conduct interviews with personnel of PT. XYZ
about related information that the writer needs to
write this thesis.
2) Secondary Data
Secondary data can be defined as primary data that
has been processed into documents. It can also be
defined as data than has been analyzed previously
from available sources.
Below are data which is categorized as secondary
data :
a. PT. XYZ Financial Statement from 2005 to 2009
b. Related literatures that can help writer to write
the thesis.
1.5.2. Data Collection Method
1) Library Research
It is a research conducted to have a strong
theoritical and formulates related foundation that will
support writer in conducting his or her research.
Sources of library research will be in form of text
books, journals based on other academic research,
booklets of seminar, magazines, internet, and other
sources which relevant with the problem that is being
researched.
2) Field Research
This research is conducted in order to gather
secondary data for analytical needs. This research
will be conducted by visiting the company which is
the subject of this research and then collect Financial
Report of PT. XYZ from 2005 to 2009 (audited)
icluding the prospectus, and other relevant data.
1.5.3. Data Analysis Method
In analyzing the data, writer will use :
1) Quantitative Method
Writer will count the company’s cost of debt, cost of
equity, WACC, and NOPAT (Net Operating After Tax).
After counting all above, writer will be able to count
company’s EVA.
2) Qualitative Method
After writer counts the company’s EVA, writer will
analyze the company’s performance based on the
theory.

1.5.4. Writing Scheme


This thesis will be written in 5 chapters with scheme as
below :

CHAPTER I. INTRODUCTION
This chapter will give an introduction about the thesis
that will cover the background of the problem, problem
formulation, purpose of the research, advantages of the
research, sources of data, data collection method, and
writing scheme.

CHAPTER II. THEORITICAL BASE


This chapter will cover theoretical base collected by
writer from various literatures on writer’s library
research that related to the concept of EVA and MVA
itself, how to calculate EVA and MVA, and related to
theoretical base about assessing the performance of
company using EVA.

CHAPTER III. COMPANY OVERVIEW


This chapter will cover the information about the
company which include the company at glance, history
of PT. XYZ, the vision and mission, corporate values, and
PT. Fortune Indonesia management.

CHAPTER IV. ANALYSIS


This chapter will cover the calculation of EVA and MVA,
also the analysis of the EVA to evaluate PT Fortune
Indonesia Tbk. financial performance whether the
company has created value or not for shareholders. A
positive EVA indicates creation of value while negative
EVA indicates demolition of value. Positive EVA increase
shareholders wealth while negative EVA reduce
shareholders wealth.

CHAPTER V. CONCLUSION AND RECOMMENDATION


This chapter will state the conclusion of the thesis about
the research on PT Fortune Indonesia Tbk using EVA and
MVA. This chapter will also cover recommendation for PT
Fortune Indonesia Tbk. that can be given for the
company to hopefully improve their performance in the
future.

¹ http://www.qfinance.com/business-strategy-best-practice/why-eva-is-the-
best-measurement-tool-for-creating-shareholder-value?page=1
² http://www.qfinance.com/business-strategy-best-practice/why-eva-is-the-
best-measurement-tool-for-creating-shareholder-value?page=2#s5
³ http://business.highbeam.com/434984/article-1G1-80486623/creating-
shareholder-wealth-financial-institutions
THESIS PROPOSAL

Using EVA and MVA Method to Evaluate Performance of PT.


XYZ in Relation with Value Creation and Shareholders Wealth
from Year 2005 to 2009

By

NAMA : Stevia M. Indrawan

NIM : 01220070090

ACCOUNTING

BUSINESS SCHOOL

UNIVERSITAS PELITA HARAPAN

2010

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