Infosys Technologies, introduced in Chapter 1, regularly provides investors with a performance measure called economic value-added (EVA).

Question:

Infosys Technologies, introduced in Chapter 1, regularly provides investors with a performance measure called economic value-added (EVA). Originally pioneered by GE, EVA measures the profitability of a company after deducting not just the cost of borrowing but also the firm’s cost of equity capital. So EVA is the after-tax return on capital employed (adjusted for the tax shield on debt) less the cost of capital employed. Companies that earn a higher return on capital employed than its cost of capital create value for its shareholders. Those that do not destroy shareholder value.

Reproduced below is EVA calculations for Infosys for 2006.

Required:

1. Did Infosys create value for its shareholders?

2. Is EVA a useful performance metric relative to net income? (Compare PAT or profit after tax, and EVA to average capital employed.)

Cost of capital:

Cost of risk-free debt (%) …………………………………………..… 7.50

Market premium ………………………………………………………….. 7.00

Beta variant ……………………………………………………………….. 0.78

Cost of equity (%)…………………………………………………………. 12.96

Average debt/Total capital (%)………………………………………. —

Cost of debt – net of tax (%)………………………………………… NA

Weighted average cost of capital (%) ………………………….. 12.96

Average capital employed ……………………………………… 6,177

PAT as a percentage of average capital employed (%) …. 40.14

Economic Value Added:

Operating profit (excluding extraordinary income) ……. 2,654

Less: Taxes ……………………………………………………………….. 313

Less: Cost of capital ……………………………………………………… 801

EVA ………………………………………………………………………. 1,540

Ratios:

EVA as a percentage of average capital employed (%) … 24.93

Cost Of Capital
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The cost of equity is the return a company requires to decide if an investment meets capital return requirements. Firms often use it as a capital budgeting threshold for the required rate of return. A firm's cost of equity represents the...