oa Meditari : Research Journal of the School of Accounting Sciences - The relationship between EVA, MVA and leverage
It is generally believed that in order to maximise value for shareholders,companies should strive towards maximising MVA (and not necessarilytheir total market value). The best way to do so is to maximise the EVA,which reflects an organisation's ability to earn returns above the cost ofcapital. The leverage available to companies that incur fixed costs and useborrowed capital with a fixed interest charge has been known and quantifiedby financial managers for some time. The popularisation of EVA andMVA has opened up new possibilities for investigating the leverage effectof fixed costs (operational leverage) and interest (financial leverage) inconjunction with EVA and MVA, and for determining what effect changesin sales would have through leverage, not only on profits, but also on EVAand MVA. Combining a variable costing approach with leverage analysisand value analysis opens up new opportunities to investigate the effect ofcertain decisions on the MVA and the share price of a company. A spreadsheetmodel is used to illustrate how financial managers can use the leverageeffects of fixed costs and the (fixed) cost of capital to maximise profitsand also to determine what impact changes in any variable like sales orcosts will have on the wealth of shareholders.
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