IntroductionEconomic 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.www.zacharyscott.com

&C&L&"AGaramond,Regular"&A&R&"AGaramond,Regular"EVA is a trademark of Stern Stewart & Co&"Helvetica,Regular"

EVA ExampleEconomic Value Added ExampleSubject Company: XYZ ConsolidatedXYZ 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 & CoXYZ ConsolidatedUnadjusted Annual Performance Data($ in Thousands)Summary Profit and Loss StatementYear12345Sales130,984124,530134,801152,327181,173Sales Growth14.4%-4.9%8.2%13.0%10.0%Cost of Sales95,74993,425100,293111,953137,567Gross Profit35,23531,10534,50940,37443,606Gross Margin26.9%25.0%25.6%26.5%24.1%S, G & A15,25616,25816,17317,48719,291Depreciation & Amortization9,6029,2259,0168,9958,322Operating Profit10,3775,6229,32013,89215,993Operating Margin7.9%4.5%6.9%9.1%8.8%Interest Expense1,8131,8231,8021,8692,064Other (Income) Expense150(65)(39)2151,395Pre-tax Profit8,4143,8637,55711,80812,534Tax Expense2,8611,3142,5694,0154,262Net Profit5,5542,5504,9887,7948,272Net Profit Margin4.2%2.0%3.7%5.1%4.6%EBITDA19,83014,91218,37522,67222,920EBITDA Margin15.1%12.0%13.6%14.9%12.7%XYZ ConsolidatedUnadjusted Annual Balance Sheet($ in Thousands)Summary Balance SheetYear12345Cash7,0849,20810,07114,4285,190Trading Assets14,07212,47213,26218,02819,358Total Current Assets21,15621,68123,33332,45724,548Property & Equipment95,430103,596113,045122,537136,762Less: Accumulated Depreciation(45,169)(54,180)(60,283)(68,120)(72,286)Net Property & Equipment50,26149,41652,76354,41764,476Deposits an Other Assets1,0741,9641,4721,3983,623Goodwill0.00.00.00.00.0Total Assets72,49173,06177,56888,27292,647Bank Credit Line0.00.00.00.00.0Accounts Payable3,8923,5743,8465,9504,759Other Accrued Liabilities11,19512,09312,80519,05614,706Current Portion of Long-term Debt1,1771,198623,6793,638Total Current Liabilities16,26316,86516,71328,68523,103Long Term Debt, less current portion34,07233,21533,07729,39525,408Other LT Liabilities7249291,0651,5221,865Net Worth21,43222,05226,71228,67042,270Total Liabilities & Net Worth72,49173,06177,56888,27292,647XYZ ConsolidatedAssumptions in red boldAnnual EVA Summary($ in Thousands)Net Operating Profit After TaxesYear12345CommentsOperating Profit10,3775,6229,32013,89215,993Net of depreciation and amortizationAdjustments:Depreciation0.00.00.00.00.0No adjustment made - book and economic depreciation are reasonably equivalentOther Expense(150)6539(215)(1,395)LIFO Adjustment0.00.00.01,041(376)Change in the LIFO ReserveResearch & Development335(150)(89)18(80)Difference between expensing all R&D and capitalizing and amortizing over 5 yearsOperating Lease Expense3,2573,2243,4123,4713,218Add back annual rents and operating lease paymentsMiscellaneous0.00.00.00.00.0Taxes(4,699)(2,979)(4,312)(6,190)(5,902)Taxes payable on adjusted operating profits excluding the tax shield from interest expense.NOPAT9,1215,7828,37012,01711,458XYZ ConsolidatedAssumptions in red boldAnnual EVA Summary($ in Thousands)Total Invested Capital and Cost of CapitalYear12345CommentsCapital Employed:Debt35,24934,41333,13933,07429,046All interest bearing debtEquity21,43222,05226,71228,67036,942Book value of equityBook Value of Capital56,68156,46559,85161,74465,989Adjustments:Capitalized R&D6,9016,7516,6626,6806,600Total R&D expenditures, net of amortizationDepreciation0.00.00.00.00.0No adjustment necessaryGoodwill0.00.00.00.00.0Add back all cumulative goodwill amortizationPresent Value of Operating Leases10,55812,64511,6789,7007,400Add present value of operating leases discounted at Kd.Total Adjusted Capital74,14075,86078,19178,12379,988Cost of Capital:Pre-TaxAfter-TaxWeightingDebt (Kd)6.5%4.3%55%Average over 5 years, should be based on the capitalization norm within the industryEquity20.0%20.0%45%Weighted Average (Kw)12.6%11.4%Tax Rate34.0%XYZ ConsolidatedAnnual EVA Summary($ in Thousands)Economic Value AddedYear12345NOPAT9,1215,7828,37012,01711,458Capital Cost8,4418,6368,9028,8949,106Annual EVA681(2,854)(532)3,1232,351Current Value of Cumulative EVA442(1,623)(2,052)7513,103NOPAT Return on Adjusted Capital12.3%7.6%10.7%15.4%14.3%Return Hurdle (cost of capital)11.4%11.4%11.4%11.4%11.4%43210.0Value Added / -Shortfall0.9%-3.8%-0.7%4.0%2.9%Other Performance MeasuresEBIT10,2285,6879,35913,67714,598EBITDA19,97914,84718,33622,88724,315Sales Growth14.4%-4.9%8.2%13.0%18.9%Operating Earnings Growth50.3%-45.8%65.8%49.1%15.1%Net Profit Growth-21.4%-54.1%95.6%56.3%6.1%Operating Margin7.9%4.5%6.9%9.1%8.8%Net Profit Margin4.2%2.0%3.7%5.1%4.6%EBITDA Margin15.1%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%Sales / Gross Fixed Assets1.41.21.21.21.3

&L&"AGaramond Semibold,Regular"&A&C&"AGaramond Semibold,Regular"- &P -&R&G

EVA TemplateEVA TemplateSubject 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 DataInsert assumptions($ in Thousands)Summary Profit and Loss StatementYear12345Sales100,000110,000121,000133,100146,410Sales Growth-12.7%10.0%10.0%10.0%10.0%Cost of Sales75,00082,50090,75099,825109,808Gross Profit25,00027,50030,25033,27536,603Gross Margin25.0%25.0%25.0%25.0%25.0%S, G & A12,00013,20014,52015,97217,569Depreciation & Amortization8,5009,0009,0009,0009,000Operating Profit4,5005,3006,7308,30310,033Operating Margin4.5%4.8%5.6%6.2%6.9%Interest Expense1,8131,8231,8021,8692,064Other (Income) Expense150(65)(39)2151,395Pre-tax Profit2,5373,5414,9676,2196,574Tax Expense8631,2041,6892,1142,235Net Profit1,6742,3373,2784,1054,339Net Profit Margin1.7%2.1%2.7%3.1%3.0%EBITDA12,85014,36515,76917,08817,638EBITDA Margin12.9%13.1%13.0%12.8%12.0%0.0Insert assumptionsUnadjusted Annual Balance Sheet($ in Thousands)Summary Financial PositionYear12345Cash7,3009,00010,10014,7005,400Trading Assets14,00012,50013,00018,00019,300Total Current Assets21,30021,50023,10032,70024,700Property & Equipment95,000103,500113,000122,000136,700Less: Accumulated Depreciation(45,200)(54,200)(60,300)(68,100)(72,300)Net Property & Equipment49,80049,30052,70053,90064,400Deposits an Other Assets1,0002,0001,5001,4003,600Goodwill0.00.00.00.00.0Total Assets72,10072,80077,30088,00092,700Bank Credit Line0.00.00.00.00.0Accounts Payable3,9003,7003,8005,9504,750Other Accrued Liabilities11,20012,10012,80019,00014,700Current Portion of Long-term Debt1,2001,200503,7003,600Total Current Liabilities16,30017,00016,65028,65023,050Long Term Debt, less current portion34,10032,90032,85029,15025,550Other LT Liabilities7009001,1001,5001,900Net Worth21,00022,00026,70028,70042,200Total Liabilities & Net Worth72,10072,80077,30088,00092,7000.0Annual EVA Summary($ in Thousands)Net Operating Profit After TaxesYear12345CommentsOperating Profit4,5005,3006,7308,30310,033Net of depreciation and amortizationAdjustments:Depreciation0.00.00.00.00.0Adjust for the difference between book and economic depreciationOther Expense (Income)(150)6539(215)(1,395)Deduct other expensesLIFO Adjustment0.00.00.01,041(376)Change in the LIFO ReserveResearch & Development335(150)(89)18(80)Add back difference between current period R&D expense and amortization of capitalized R&DOperating Lease Expense3,2573,2243,4123,4713,218Add back annual rents and operating lease paymentsMiscellaneous0.00.00.00.00.0Taxes(2,700)(2,869)(3,431)(4,290)(3,876)Deduct taxes payable on adjusted operating profits excluding the tax shield from interest expense.NOPAT5,2425,5696,6608,3287,5240.0Insert assumptionsAnnual EVA Summary($ in Thousands)Total Invested Capital and Cost of CapitalYear12345CommentsCapital Employed:Debt35,30034,10032,90032,85029,150All interest bearing debtEquity21,00022,00026,70028,70033,039Book value of equityBook Value of Capital56,30056,10059,60061,55062,189Adjustments:Capitalized R&D6,9016,7516,6626,6806,600Add historical R&D expenditures, net of amortization. Amortize over period that value is expected to be derivedDepreciation0.00.00.00.00.0Add back excess book depreciation in prior periodsGoodwill0.00.00.00.00.0Add back all cumulative goodwill amortizationPresent Value of Operating Leases10,55812,64511,6789,7007,400Add present value of operating leases discounted at Kd.Total Adjusted Capital73,75975,49577,94077,92976,188Cost of Capital:Pre-TaxAfter-TaxWeightingDebt (Kd)6.5%4.3%55%Equity20.0%20.0%45%Weighted Average (Kw)12.6%11.4%Kw should be weighted based upon the capitalization norm for the industryTax Rate34.0%0.0Annual EVA Summary($ in Thousands)Economic Value AddedYear12345NOPAT5,2425,5696,6608,3287,524Capital Cost8,3798,5768,8548,8528,655Annual 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 Capital7.1%7.4%8.5%10.7%9.9%Return Hurdle (cost of capital)11.4%11.4%11.4%11.4%11.4%43210.0Value Added (-Shortfall)-4.3%-4.0%-2.8%-0.7%-1.5%Other Performance MeasuresEBIT4,3505,3656,7698,0888,638EBITDA13,00014,30015,73017,30319,033Sales 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 Margin4.5%4.8%5.6%6.2%6.9%Net Profit Margin1.7%2.1%2.7%3.1%3.0%EBITDA Margin12.9%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 Assets1.11.11.11.11.1

&L&"AGaramond Semibold,Regular"&A&C&"AGaramond Semibold,Regular"- &P -&R&G

AdjustmentsNet Present Value of Future Lease PaymentsYear1234512,334,2212,735,2083,011,2333,071,4183,010,86621,696,1252,710,7372,960,0802,940,1232,134,33331,639,3932,675,5742,829,5682,073,8651,679,88341,616,1802,586,4362,006,9331,655,4231,460,84851,528,0591,785,4361,627,6101,459,475225,86564,584,9773,148,3571,678,993225,8650.03,2573,2243,4123,4713,218NPV10,55812,64511,6789,7007,400LIFO AdjustmentYear12345Market5,6446,3236,3146,652FIFO Balance5,6446,3236,3146,6527,6997,979LIFO Balance6,3756,4866,7577,4316,6587,314LIFO Reserve(731)(162)(442)(778)1,041665Capitalized R&DYear12345R&D Expenses2,7813,4513,6183,3093,3303,3463,2183,833Amort 1(927)(1,150)(1,206)(1,103)(1,110)(1,115)(1,073)(1,278)Amort 2(927)(1,150)(1,206)(1,103)(1,110)(1,115)(1,073)Amort 30.00.0(927)(1,150)(1,206)(1,103)(1,110)(1,115)Capital Balance6,9016,7516,6626,6806,6006,967335(150)(3,419)(3,328)(3,298)(3,466)(3,283)(3,459)(3,419)(3,328)(3,298)(3,466)Difference Expense335(150)(89)18(80)367Depreciation CGS9,1288,7178,4568,2697,646SGA360399452619578Cash flow9,4889,1168,9098,8888,2239,4889,1168,9098,8888,223