Explain essential hypotheses for Economic Value Added
Which are the essential hypotheses so that valuations of the Economic Value Added (EVA) give similar results to discounting cash flows?
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A Fernández (2002 and 2004) demonstrate that discounting expected EVAs gives the same value as discounting cash flows (so long as, from an accounting viewpoint, the increase in value of the Shareholders’ Equity equivalents the net income minus dividends). When E is the value of the shares and Evc is their book value, in that case:
E0 = Evc0 + VA (EVA; WACC), here EVAt = NOPATt – (Dt-1 + Evct-1) WACC
The Net Operating Profit after Taxes (NOPAT) is the profit of the unleveraged company as the profit before interests and after taxes. The Economic Value Added depends mainly upon two accounting parameters: its profit and the book value of debt and equity.
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