1 Article ECORFAN Journal RISKS August 2013 Vol.4 No.10 1077-1086 Economic value added (EVA) as an indicator for financial decisions: An Application to the Province of Santa Elena, Ecuador SOLORZANO-Víctor † ⃰, GARCIA-Lupe ´, RAMOS-María ´, VARGAS-Oscar Universidad Península Santa Elena, Avda. principal La Libertad - Santa Elena, La Libertad, Ecuador, +593 4-278-0018. ´ Universidad Autónoma del Estado de México, Paseo Universidad, Universitaria, 50130 Toluca de Lerdo, Estado de México ´´ National Chengchi University, No. 64, Sec. Zhinan Road, Taipei, +886 2 2939 3091. Received December 4, 2012; Accepted April 17, 2013 ___________________________________________________________________________________________________ This paper analyses the need to use alternative methods to the traditional accepted techniques applied in investment analysis for associative groups. This paper exposes that the technique economic value added (EVA) can contribute to measure other aspects involved in financial decisions for associative groups omitted in traditional indicators of project evaluation, net present value (NPV) and internal rate of return (IRR) such as i) evaluation of the productive activity of the associated strategies popular and solidarity economy ii) quantifying the profitability generated by the implementation of the project, iii) identifying the main impacts generated by implementing the creation of the company and iv) the identification of the economic value added. This tool permits the employment of probabilistic scenarios, in order to simulate changes in the input parameters for determining when the EVA tends to zero, making a comparative analysis with the NPV. It is used to calculate the weighted average cost of capital (WACC) market financial returns because you cannot get or inefficient conduct the study by estimating the beta for the CAPM method because Ecuador has not data from the stock exchange. We execute an application of this method a processing plant for the production of salt in Jose Luis Tamayo, situated in the Province of Santa Elena, Ecuador. Economic value added (EVA), net present value (NPV) and internal rate of return (IRR), Santa Elena Peninsula, Ecuador ___________________________________________________________________________________________________ Citation: Solorzano V, Garcia L, Ramos M, Vargas O. Economic value added (EVA) as an indicator for financial decisions: An Application to the Province of Santa Elena, Ecuador. ECORFAN Journal 2013, 4-10:1077-1086 ___________________________________________________________________________________________________ ___________________________________________________________________________________________________ ⃰ Correspondence to Author (email: [email protected]) † Researcher contributing first author. 2 Article ECORFAN Journal RISKS August 2013 Vol.4 No.10 1077-1086 © ECORFAN Journal-Mexico www.ecorfan.org 1. Introduction Business development in the Province of Santa This research aims to propose an Elena has been significant in recent years, alternative investment for three associative companies and associated groups have gained groups are: i) the White Mountain Association, strength due to various factors that have helped ii) Magdalena 4 and iii) Magdalena. We want to to converge these activities in the province, one evaluate the productive activity partners, of the variants has been the development of evaluate strategies popular and solidarity popular and solidarity economy strategies, who economy, quantify the yield generated the have improved the living conditions of the development and marketing of salt as raw population. material, through the economic value added to determine if it is creating value for the owners The objective of any economic entity pass the salt mines of the status quo to a either company, corporation, association situation where profit margins are what you groups, is the generation of wealth; otherwise it want to contribute to development. The could not distribute profits, increase the value research tests the hypothesis that "The of the shares, or could not reinvest in social Economic Value Added (EVA) is a financial responsibility. A company creates value if the indicator to decide the creation of the return on investment is greater than the cost of company." capital, if instead the return on investment is less than the cost of capital, value is destroyed. 2. Economic value added as an indicator for This paper shows the application of financial decisions economic value added (EVA), as a tool to evaluate an investment proposal, as an There are indicators for the evaluation of alternative method to the traditional indicators traditional projects such as Net Present Value such as are the net present value (NPV) and (NPV), and Internal Rate of Return (IRR), a internal rate of return (IRR), through a case study of John Graham and Campbell Harvey study in the development and marketing of (2001) on the use of different techniques and products derived from the salt in the parish Jose models set forth in the "financial theory of the Luis Tamayo, Canton Province of Santa Elena firm" by 392 executives from a wide range of Salinas. The difference between using the North American companies and its main updated NPV and EVA to evaluate investment conclusions were: “large companies rely is that the former compares the amount to be strongly on present value techniques and the invested with future cash flows that generate asset pricing model of capital, while small investment. Instead, using the EVA does not businesses are relatively at ease using the follow that investment income before taxes criterion of recovery period”. However after interest (UAIDI) includes the deduction of following the new trends an alternative method annual depreciation on investment. is the Net Present Value (NPV) is presented below: 3 Article ECORFAN Journal RISKS August 2013 Vol.4 No.10 1077-1086 capital and own external resources that have been invested in assets". 2.1 Definitions of Economic Value Added (EVA) The economic value added is positive when the company has generated a return that exceeds the opportunity cost of shareholders, According to (Gitman, 2007 p. 417) EVA is a therefore, value is created. When the economic popular measure used by many companies to value added is negative, it means that the determine whether an investment (proposed or company has not generated a return that exceeds the cost of capital to the shareholders, existing) positively contributes to the wealth of and therefore the value is being destroyed. the owners. The application of EVA requires using the weighted average cost of capital The first notion of EVA was developed (WACC) by (Alfred Marshall 1890) The Principles of Economics: "When a man is engaged in a Calculating the Economic Value Added business, its earnings for the year are excess (EVA) is an effective tool which allows to revenues received during the year on their know if a company creates or destroys failing payouts. The difference between the value of value for its owners, managing to go far beyond the plant, inventories, etc., the end and the traditional measures to evaluate the overall beginning of the year is taken as part of its performance management or an organization. inputs or as part of their payouts, according to whether there has been an increase or decrease Although the EVA and value generation in value. What remains of their profits after have emerged as developments of the past deducting interest on capital at the current rate, decade, the economic and financial theory has it is usually called its start or administer benefit approached these concepts quite some time. ". For (Oriol Amat 1999), the EVA can be The EVA concept is a variation of what defined as "what remains once have been has traditionally been called "residual income deducted from income, all expenses including or profit", which was defined as the result that the opportunity cost of capital and taxes, all capital. There have been a number of costs, including the opportunity cost of capital advantages of the indicator and use EVA has and taxes". In other words, EVA is what several defenders. Thus (Koller and Meteache remains once all expenses have been addressed 1997) note that "The EVA is a financial and satisfied a minimum return expected by measure to assess the performance powerful shareholders. Therefore, a company creates professional but compensation effects may be value when the return generated exceeds the incomplete and you have to combine it with opportunity cost of shareholders. others." (Arthur Andersen 1997) indicates that the analysis of historical data shows that "EVA For (Percy Olivares Vilchez 2000), is closely related to movements in stock prices". "economic value added is the residual amount that remains after you have deducted from The name of EVA is a registered income, all the expenses, taxes and the cost of trademark of the consultant, Stern Stewart & Solorzano V, Garcia L, Ramos M, Vargas O. Economic value ISSN-Print: 2007-1582- ISSN-On line: 2007-3682 ® added (EVA) as an indicator for financial decisions: An ECORFAN All rights reserved. Application to the Province of Santa Elena, Ecuador. 4 Article ECORFAN Journal RISKS August 2013 Vol.4 No.10 1077-1086 Co., who in their advertising says: Forget EPS According to a study by John Graham (earnings per share), ROE and ROI. and Campbell Harvey1 as shown in the table The true measure of the performance of below (# 1). your company is EVA, (Fernández 1999), p. 209.