Cash Value Added
By James Bell
- Finance ,
- 14 Nov
Cash value added (CVA) determines the residual cash generated in excess of the required cash flow return on investment (CFROI). It is the cash version of Economic Value Added (EVA) and was created by the Boston Consulting Group. The Boston Consulting Group considers this a further evolution of the EVA while still acknowledging it’s own limitations (source).
There is a lot to unpack here and these nested formulas can seem complicated at first. The nice part is that you can essentially drill down through the math and it can be helpful to think of them in layers or levels. If nested functions are easy for you and you primarily use excel, learning a programming language like Python is a great next step.
Cash Value Added Direct Method
![\[ CVA = Gross\, Cash\, Flow\, -\,Economic\, Depreciation\, -\, Capital\, Charge \]](http://stumptownfin.com/wp-content/ql-cache/quicklatex.com-08e422bc12f2d782ef41a6a4d104acbb_l3.png "Rendered by QuickLaTeX.com")
Each variable in CVA is made up of other formulas. Let’s now expand each variable to go into more detail for a deeper look.
Gross Cash Flow
![\[ Gross\, Cash\, Flow = adjusted\, EBIT + interest\, expense\, +\, depreciation \]](http://stumptownfin.com/wp-content/ql-cache/quicklatex.com-da5548d44cbfbde62ed623826bedaee9_l3.png "Rendered by QuickLaTeX.com")
This is our starting point. Adjusted EBIT consists of the earnings that are left after you subtract all expenses except taxes, interest, and other non-cash expenses such as stock options, net realized gains/losses, etc.
Economic Depreciation
![\[ Economic\, Depreciation = \frac{WACC}{(1+WACC)^n-1} \]](http://stumptownfin.com/wp-content/ql-cache/quicklatex.com-bbb447dec3c5118d85897dfdb839063b_l3.png "Rendered by QuickLaTeX.com")
This is different than the depreciation in accounting which is typically set on a schedule such as straight line, MACRS, double declining balance, etc. Economic Depreciation is closer to a market value adjustment. We would depreciate due to a decrease in future cash flows or other market conditions such as a reduction in appraisal value of an asset.
Weighted Average Cost of Capital
Here is an article that goes over WACC in more detail.
Capital Charge
![\[ Capital\, Charge = Cost\, of\, Capital\, x\, Gross\, Investment \]](http://stumptownfin.com/wp-content/ql-cache/quicklatex.com-37e2fa90a99e70664890ed586f94d647_l3.png "Rendered by QuickLaTeX.com")
We need Gross Cash Flow to cover the Capital Charge and Economic Depreciation for CVA to be positive in the direct method.
Cash Value Added Indirect Method
![\[ CVA = (CFRIO - WACC)\, x\, gross\, investment \]](http://stumptownfin.com/wp-content/ql-cache/quicklatex.com-a0eb905713a6693494d85c90ed420ea5_l3.png "Rendered by QuickLaTeX.com")
where
= Cash Flow Return on Investment
= Weighted Average Cost of Capital
Cash Flow Return on Investment
![\[ CFRIO =\frac{Gross\, Cash\, Flow - Economic\, Depreciation}{Gross\, Investment} \]](http://stumptownfin.com/wp-content/ql-cache/quicklatex.com-1611a2ecd1baefb5b60b19b00460d061_l3.png "Rendered by QuickLaTeX.com")
CFRIO measures the cash flow return provided by capital.
Gross Investment
![\[ GI = Book\, Value\, of\, Company\, +\, Accumulated\, Depreciation \]](http://stumptownfin.com/wp-content/ql-cache/quicklatex.com-943441ead3b6ffb2ee9342477a41ff2e_l3.png "Rendered by QuickLaTeX.com")
Gross Investment is the amount of money that has been invested in a company without taking into account depreciation.