Economics Economic Value Added Economic Value Added Essay

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  • Subject: Business
  • Type: Essay
  • Paper: #66897913

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Economic Value Added

Economic Value Added is an analytical tool which was developed in 1982 by Joel Stern and G. Bennett Stewart and has been widely accepted as a means of measuring a company's real profitability. This tool is unique because it involves calculating "the firm's residual profitability, net of both the direct cost of debt capital and the indirect cost of equity capital." (Grant, p. 2) Debt capital can be defined as the amount of money a company must spend on its current debt, including interest and other fees. However, because most interest expenses can be deducted from taxes, the calculation is often measured after taxes. Equity capital is a much more complicated factor in the equation because it deals with the value of all the assets of the company, which would normally be owned by the shareholders, but are necessary for the running of the company. This can be calculated by estimating the current market value of everything owned by the company and subtracting the total of all liabilities.

Because EVA is a complex equation, and there are no established standards for its use, different companies may calculate EVA differently, and thus it may not provide for a fair form of comparability. Also, because of the prominence of capital in the equation, companies that are "sensitive to the availability of capital" may not be suitable to use EVA. Another disadvantage with the use of EVA is the fact that since it is based upon accounting principles, accountants can change factors to some degree to change the resulting EVA figure. For example, accountants can move figures in or out of the accounting period to adjust the EVA. Finally the most prominent issue dealing with EVA is that it is "results oriented," and not a very good tool to indicate the root causes of operational inefficiencies. While it may give results which indicate that things need to be changed, it cannot indicate which specific changes must be made.

EVA is a tool that is widely used by companies all over the globe. For example, Whole Foods, a grocery store chain with over 300 stores in North America and the United Kingdom is a user of this formula. Whole Foods publicly states that they use EVA "as a basis for our business decisions and for determining incentive compensation." (Whole Foods) They also use EVA for "capital investment decisions, including evaluating new store real estate decisions and store remodeling proposals." (Whole Foods) This company will only invest in projects that will add long-term value to the company and focus on EVA in order to improve their business. Whole foods believes that their decentralized culture is one of their core strengths, and that EVA is the best financial framework that each store team can use to improve the profitability of each store.

But Whole Foods is also very careful to explain that "EVA is a measure not in accordance with, or an alternative to, generally accepted accounting principles (GAAP)" (Whole Foods), and they only use it as an internal measurement for their own purposes. They do not base any public, or legal financial statements on this calculation.

2. Import and Export Quotas

Import Quotas are physical restrictions on the quantity of products that a country will allow to be imported during a specific time period. "The quota generally limits imports to a level below what would occur under free-trade conditions." (Hanson and Carbaugh, 2005, p. 155) A government usually accomplishes this by requiring an import license on a product. On the other hand are what are referred to as "export quotas" which basically has the same effect as import quotas, restricting the amount of product entering a country, but are self-imposed restrictions. For example, the U.S. "often requires the foreign government to agree to impose export quotas on products destined for the United States." (Johnson and Bade, 2010, p. 255) These are sometimes called Voluntary Restraint Agreements (VRE).

Import quotas restrict the number of products entering into a country, and generally lead to an increase in the cost of the product. But they can also lead to an increase in demand for a product. And if the idea is to limit the amount of an imported product in order to maintain a domestic industry, then import quotas can be an effective tool. Export quotas can also be beneficial is certain ways, for instance the price to enter into trade with another nation may be the imposition of an export quota. While this may limit the amount of product exported, selling a small amount to a new market is better than selling none. Also, maintaining export quotas can limit the amount of a product exported to foreign markets, and thus increase the demand and price for the product. However, limiting exportation generally limits production and the goal of most companies is to increase production and sales.

Due to an increased demand for clean energy, in 2010, China's exports of coal dropped from almost 83 million tons to just over 19 million. (China Mining, 2011) Because of the drop, China has imposed export quotas on the exportation of coal, limiting exports to 25.5 million tons. This has led to an increased in demand from overseas markets and an increase in price, which plummeted in 2010. In 2011, the Chinese export quotas on coal have been risen to 38 million tons.

If export quotas have been beneficial to the Chinese coal industry, the import quotas set by the Mexican government on sugar have been the cause of great misfortune. In the 2009/2010 sugar production season, bad weather and other factors led to a shortfall of production of just 4.5 million tons. (Bremer, 2010) However, the Mexican national sugar council set sugar import quotas based on an estimated 4.97 million ton domestic production. The difference in predicted and produced sugar led to a shortage of sugar in Mexico. Sugar prices hit an all time high and ordinary Mexicans were going without. As a result, the Mexican government was forced to increase the import quotas on sugar by 250,000 tons from the period from February to the end of May 2010. While attempting to maintain their domestic sugar industry by limiting the importation of inexpensive sugar from foreign sources with import quotas, these actually led to a shortage of sugar, and rapid increase in sugar prices, and the eventual raising of the sugar quotas.

3. The Four P's

The "Four P's" are product, price, place, and promotion, and each is a variable that can be controlled in creating a marketing mix that will attract customers. "Product" refers to the goods or services a company offers its customers, and this is simply more than the physical product one offers. It also includes the packaging of that product, the "quality, features, options, services, warrantees, and brand name." (Ehmke) "Price" is the amount one charges the customer for the product or service and should reflect the cost per item incurred by the company as well as a profit margin. In choosing a pricing strategy, it should be based on the product, competitive market, customer demand, and other products a company offers.

When one wants to sell a product they must choose a channel of distribution to get the product to the customers, this is what is meant by "Place." How a product gets to the customers is highly dependent upon the product and can usually go through two channels: either the company sells directly to the customer, or they sell the product through an intermediary. Whatever the channel, the company will have to decide whether to use intensive, selective, or exclusive distribution. Extensive distribution attempts to place a product in as widespread an area as possible and often at the lowest prices possible. Selective distribution restricts the outlets for the product to a limited number of retailers, for instance only selling a product through "high-end" retailers. Exclusive distribution limit's the product's sales to a single reseller, one example might be a product that is sold exclusively at Walmart. Finally, "Promotion" refers to the advertising and selling part of the equation, and it is instrumental in letting potential customers know what you have for sale. There are many ways to inform the customers of your product including television, radio, print, word of mouth, and electronic media sources. How one advertises their product is an important aspect of the marketing system.

Early in 2007, Honda gas/electric hybrid car, the Accord Hybrid, was selling dismally. While Toyota's sold more than 75,000 hybrid Prius' in the first five months, Honda sold only 1700 hybrid Accords. Honda failed to follow the "Four P's" of marketing, first off the car was a strange hybrid which generated and stored electrical energy from deceleration and breaking is not an effective, or even overly efficient means of using electric power. Also, by selling the Accord hybrid at over $31,000, more than $9,000 above the price of a normal Accord, Honda's pricing strategy was flawed. When it came…

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