Market value added (MVA) is the amount of wealth that a company is able to create for its stakeholders since its foundation. In simple terms, it’s the difference between the current market value of the company’s stock and the initial capital that was invested in the company by both bondholders and stockholders.
The concept of market value added is fairly similar to that of economic value added (EVA). The article below explains the difference between the two while also highlighting the significance of computing market value added.
Economic Value Added vs. Market Value Added
The first thing to keep in mind is that investors and lenders use different techniques to establish the value of a company. It is particularly important for those looking to invest in a particular organization. Valuations are also used to determine whether a given company is a good credit risk.
Investors use two main techniques to determine the value of a company, namely:
1. Economic Value Added (EVA)
Invented by Stern Stewart & Co., economic value added (EVA) measures the real profits generated by a company. Essentially, it’s used to determine how profitable an organization has become within a given period of time.
That said, EVA is computed by subtracting the product of the company’s initial capital and the percentage cost of capital from its after-tax net profit. To illustrate the fact, let’s consider the example below:
Company ABC generated after-tax net profits amounting to $200,000 in 2018. The amount of capital the company invested was $2 million at an average cost of capital of 8.5%. To calculate ABC’s EVA:
$200,000 – ($2,000,000 * 8.5%) = $30,000
The $30,000 figure implies that Company ABC generated enough profits to cover its initial cost of conducting business.
2. Market Value Added (MVA)
Market value added, on the other hand, is merely the difference between the current value of the company on the market and the initial contributions made by its investors.
Contrary to what many assume, MVA is not a performance indicator. Instead, it is a metric used to measure wealth. Essentially, it is used to determine exactly how much value the firm has accumulated over time.
If a company has been performing well, it means that it has been retaining earnings. The earnings boost the book value of the company’s stocks, encouraging investors to increase the prices of their shares in anticipation of future earnings. The whole process causes the company’s market value to soar.
Although one may encounter different formula for computing MVA, the simplest one is:
MVA = Market Value of Shares – Book Value of Shareholders’ Equity
To find the market value of shares, simply multiply the outstanding shares by the current market price per share. If a company offers owns preferred and ordinary shares, then the two are summed together to find the total market value.
As an example, consider Company XYZ whose shareholders’ equity amounts to $750,000. The company owns 5,000 preferred shares and 100,000 common shares outstanding.
The present market value for the common shares is $12.50 per share and $100 per share for the preferred shares.
Market Value of Common Shares = 100,000 * $12.50 = $1,250,000
Market Value of Preferred Shares = 5,000 * $100 = $500,000
Total Market Value of Shares = $1,250,000 + $500,000 = $1,750,000
Using the figures obtained above:
Market Value Added = $1,750,000 – 750,000 = $1,000,000
Advantages of Market Value Added (MVA)
1. Makes companies more attractive to potential investors
Investors will always prefer companies with higher MVA because it shows the firm’s ability to create wealth for its stockholders. In other words, a high MVA shows that the organization is healthy and succeeding – a factor that signals a high probability of generating significant returns later on. So, for investors who are not interested in high-return investments, a firm with a high MVA seems like a safe option.
2. Boosts the survival chances of a company
In the corporate world, nothing is 100% sure. A company could be making billions of profits one minute and declaring bankruptcy the next time. However, for a company to register a high MVA, its likelihood to thrive is certainly high.
A high MVA means the company is generating enough wealth so it will continue to attract investors. It then means that it will continue to expand its operations, earn more profit, and stay ahead of its competitors.
Market value added is a wealth metric used to measure the amount of capital that shareholders have invested in excess of the current value of the company. Simply put; it determines whether the business has increased or decreased in value since its inception.
MVA is computed by first finding the total market value of the company’s shares. The stockholder’s equity or initial capital is then subtracted from the resulting sum. A higher MVA is preferred because it indicates that the company is generating enough money to cover the cost of capital.
CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: