Calculating Economic Value Added (EVA) for Rio Tinto Company

This report provides a comprehensive analysis of Economic Value Added (EVA) for Rio Tinto, a prominent multinational company in the metals and mining industry. The paper begins with an introduction to EVA, explaining its role in measuring a company's financial performance based on residual wealth and its formulation by Stern Value Management. The report then delves into a detailed discussion of Rio Tinto, including its business operations, global presence, and strategic focus on shareholder value. The core of the analysis involves calculating Rio Tinto's EVA, which requires understanding the Weighted Average Cost of Capital (WACC), Net Operating Profit After Taxes (NOPAT), and invested capital. The report provides a step-by-step calculation of WACC and EVA, using data from Rio Tinto's financial reports. The findings reveal a positive EVA, indicating that the company is generating substantial returns from its investments. The report also explores the applications, advantages, and disadvantages of EVA as a financial metric, providing insights into its practical use and limitations in corporate management.

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Strategic Corporate Management
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Executive Summary
The paper deals in the estimation and calculation of Economic Value Added of a European
Company. The Company, Rio Tinto has been chosen to estimate the value of EVA and the
usefulness of the value in the estimation of costs and benefits of the company. EVA denotes the
performance of firms and the amount of return from initial investments.
Table of Contents

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1. Introduction..................................................................................................................................3
2. Discussion....................................................................................................................................4
2.1 General Introduction of the Company...................................................................................4
2.2 Calculation of Economic Value Added.................................................................................5
2.3 EVA Calculation for Rio Tinto..............................................................................................5
2.3.1 The effect of WACC on businesses................................................................................6
2.3.2 Calculation of WACC.....................................................................................................7
2.4 Application of EVA.............................................................................................................10
2.5 Advantages of EVA.............................................................................................................11
2.6 Disadvantages of EVA........................................................................................................12
3. Conclusion.................................................................................................................................13
4. Reference List............................................................................................................................14

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1. Introduction
The paper is related to the calculation of Economic Value Added (EVA) corresponding to
a particular company and to understand the economic benefits and costs of EVA calculations on
businesses. EVA is used to estimate the economic and financial performance of the company on
a basis of residual wealth. This residual is measured from the operating profit by withdrawing the
cost of capital with the adjustment of taxes from cash. Economic Value added is also known as
the economic profit of a firm as it captures the real economic profit of the firms Salehi et al.
(2014, p. 259-283). This process was formulated by a management consulting firm known as
The Stern Value Management.
EVA is explained as the percentage rise in the difference of a firm’s rate of return with
respect to the cost of capital. Generally, this measure is used to calculate the change in the
financials, which is generated from the invested funds by the companies into the valuation of
their business Dunbar (2013, p.54). A positive return from EVA determines that the company is
actively producing its value from the invested funds, while a negative EVA determines that the
firm is not deriving its value from the invested funds. In order to estimate the disadvantages and
advantages of EVA, a European company named Rio Tinto is chosen. The aim of the paper is to
estimate the EVA of Rio Tinto Company and how effectively it is used to measure the financial
stability in the market.
2. Discussion
2.1 General Introduction of the Company
Rio Tinto is a famous multi-national company who is engaged in the business of metals
and it’s mining. It is one of the biggest companies in the world who have its branches in thirty-
five countries, six continents with the major corporations in the regions of Australia and Canada.

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Rio Tinto has one of the head offices in London (Europe). The Company was established during
1873, when a group of investors bought a mining network in Rio Tinto. The chosen company has
effectively developed itself enormously since the beginning of its establishments, by a large
series of acquisitions and mergers. The objective is to make it, as one of the leading producers
globally in the field of copper, aluminium, uranium, iron ore and diamonds. Previously, the
company dealt only in the extraction and production of minerals, which has been expanded to
other r. Rio Tinto has significantly expanded its operations in the refining sector, specifically for
refining iron ore and bauxite Chiwamit et al. (2014, p. 144-180).
In London, Rio Tinto deals in the trading of London Stock Exchange where it is a
component of FTSE 100 Index. They are the pioneers in the extraction of minerals by releasing
lower amounts of carbon dioxide from the hydropower of aluminum foil and aims to progress
towards a better future. Their businesses is planned in a way such that sustainability can be
maintained along with creation of environment friendly programs for efficient legacy
management and tax transparency. Rio Tinto partners for a better human progress with lighter,
fuel efficient techniques. The company has various partners like International Council on Mining
& Metals and works with the leading NGOs to enhance the living standards of communities with
minimum impact on the planet Bhasin, Madan Lal and Junaid (2013, p.107-137).
2.2 Calculation of Economic Value Added
EVA is measured by three basic components such as those of invested capital, the
operating profit after taxes and the cost of capital weighted on an average basis. EVA is
calculated by the given formula Awan et al. (2014, p.140-152),
EVA= NOPAT-(Invested capital * WACC) =
Where NOPAT= Net Operating Profit after Taxes

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WACC= Weighted Average Cost of Capital
Capital investment is the amount of money invested for capitals to fund a specific project.
The weighted average cost of capital is defined as the average rate of return expected by the
company for paying its investors. These weights are calculated as a fraction of amount derived
from the capital structure of each financial source. The final value of the financials is
incorporated after subtracting the current liabilities from the quantity total assets Bluszcz, Anna,
and Anna Kijewska (2013, p.109-123).
The aim of EVA calculation is to compute how the cost is incurred in the investment of
capital for certain projects and then implicate whether the cash investment has benefitted the
company or not. In any business, initial investment is necessary for gathering huge profits. The
calculation of EVA, measures the minimum charge which is required to make the investment
worth-while by the investors Lai (2014, p.5-8).
2.3 EVA Calculation for Rio Tinto
Rio Tinto has well planned strategies that distinguishes itself from other companies.
Their strategy is to derive superior values for the shareholders by meeting customer satisfaction
with collection of maximum cash from the world wide assets and allocating them in the most
efficient way possible. The financial stability of the company is a strong force that drives the
company towards growth outcome. The key assets are located in countries which experiences a
strong economic growth and development Olías, Manuel, and José Nieto (2015, p.295-316). The
firm generates a net worth of about 11.8 billion dollar with the total shareholder return of 33.4
percent, over the past five years before 2018. The market and financial condition of Rio Tinto
can be estimated by EVA calculation. This section deals in the calculation of EVA for Rio Tinto
and interpret the results.

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In order to estimate the EVA for Rio Tinto Company, estimation of weighted average
cost of capital (WACC) is necessary. Before measurement of EVA, familiarity with certain
words is essential. WACC is also known as weighted average cost of equity and cost of debt.
The analysis of WACC assumes capital markets to have returns that is perceived with risky
investments for estimation of equity and debt Nakhaei, and Nik (2013, p.1589-1598). The
interest rate at which the net present value of cash flow of the goods is measured, is called the
internal rate of return (IRR) which can be either positive or negative. The IRR value has be equal
to zero, so as to denote the exact cost spent on capital goods. WACC should be lower than or
equal to IRR, otherwise firms will get high costs on the operated projects Shah et al. (2015,
p.38). If the value of IRR exceeds that of WACC, it means that the rate of return of the firm is
more than the costs and an investor will proceed with the investment. Whereas, a lower rate of
return than WACC denotes that the firm has rising cost in comparison to its rate of return and in
such situations, investors decide against the investment.
2.3.1 The effect of WACC on businesses
Running a business requires a lot of investment for its growth prospectus. Companies
need to take a certain amount of loan from the shareholders and depending on the business plan,
shareholders offer a sum of money as investment amount Ismail (2013. p.1757-1764)). This
amount is dependent on the size of firms and revenue. However, the firm has to pay a sum of
money as the interest on the borrowed principle amount. This amount can be indicated, either by
physical or capital assets of the company and the interest cost that needs to be conveyed is
known as the capital cost. When investors estimate the amount to be invested, they measure the
value WACC at first. Suppose that an investor is interested in making an investment in a
company where the WACC is 12 percent where the net return from the investment is 11 percent.

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As WACC is greater than the return on capital, the investor will decide against the investment
Iazzolino, Gianpaolo and Domenico (2013, p.547-563).
2.3.2 Calculation of WACC
Formula for measuring WACC= (E/V * Ke) + (D/V) * Kd * (1- Tax rate)
 V= Total market value of Debt and Equity
 D= Market value of the debt
 E= Market value of equity
 Tax rate= Corporate tax rate
 Kd= Cost of debt
 Ke= Cost of equity
The market value of equity is value of the company’s market capitalization which is
measured by the multiplication of outstanding market shares of the company and the market
price of each share in that particular period Bluszcz, Anna, and Anna Kijewska (2016, p.109-
123) The value of bonds in the market is known as the debt value of companies. Given below is
the estimated values of equity and debt for Rio Tinto.

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Figure 1: The annual report of the Rio Tinto Company for the year 2018
Table 1: Calculation of weighted average cost of capital for Rio Tinto based on report of 2018

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Cost of equity= Risk free rate of return + Beta* (Market rate of return – Risk free rate of Return)
Cost of debt= (Risk free rate+ credit spread) * (1- Tax rate)
Where Beta is known as the amount of risk, estimated by regression value of company’s
stock price. Credit spread is the credit rating and a poor credit rating raises the credit spread and
vice-versa. The debt cost is also estimated by the expense generated from the interest when the
credit rating cannot be attained properly which is done in the case of Rio Tinto.
Table 2: Estimation of debt cost for Rio Tinto in 2018
Table 3: Calculation of the return from capital from data of 2018
The WACC of Rio Tinto is 28.9 percent of the overall cost as measured from the Annual
Report of 2018. The calculation of EVA requires the after tax operating income, the total assets
and the current liabilities which is obtained from the data of company’s financials. After tax
operating income denotes the income after subtracting the money spent as tax and Rio Tinto has
the following values Franco et al. (2013, p.4159-4173).

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Table 4: The cost of assets, liabilities and after tax operating income from annual report (2018)
measured in dollars
Now the EVA of Rio Tinto Company is calculated with the formula,
EVA= After tax operating income- {WACC* (Total assets – current liabilities)}
= 13925- {0.89 *(90949-10571)} = 11595.86 dollars
Thus, Rio Tinto has an EVA of 11595.86 dollars, which is quite high as per the investors. This
denotes the fact, that the company can get greater profit margins from its investments.
2.4 Application of EVA
Positive EVA implicates that the company is generating more than the required minimum
returns Berzkalne, Irina and Elvira (2014, p.887-896). If a company earns negative EVA, then
the investors care likely to face some questions regarding the capital investment because the net
return are showing a negative result and whether those assets could be invested somewhere else.
Investors then investigate why the previous plan had not been effective and what has to be done
in order to regain the positive returns. Before making an initial investment managers can plan if
the rise in earnings is enough to recover the cost of assets.
Managers can easily keep a track of the growth earnings and is used as an incentive
compensation system for explicit monitoring of the company Huynh et al. (2013, p. 34-40). EVA
can be improved either by increasing the level of earnings or with the reduction of employed
capital. This improvises the fact the underutilized assets needs to be flushed or disposed of.

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Working capital has to be decreased and must not be added casually for estimating the financial
performance of firms.
2.5 Advantages of EVA
The performance of a company is reflected by the assessment of EVA with its
management operations. A minimum investment is mandatory for the operation of business and
the amount that has to be invested can be understood from the EVA by the firm Limarev (2015,
489). The financial state of the company is denoted by the EVA where a positive value
determines a well financial position and vice-versa. The creation of wealth makes businesses
profitable as they can give higher amounts of return to the shareholders who can then be
interested in investing greater amounts. The amount of estimated revenue always differs from the
actual revenue because of the depreciation and change in the consumer demand for different time
period. Depreciation is the cost incurred when some of the capital or goods have lost its value
and cannot be sold Roblek, Vasja, et al. (2013, p.554-568)
EVA is a better measure than the growth in earnings and highlights those parts who are
not performing up to the mark. The calculation of EVA indicates the areas which needs more
focus and investment in terms of money. It puts forth the methods of wealth creation by the
inclusion of balance sheet items. Managers and planners can stay updated about the company
requirements and be aware of the threats of financial crisis. While taking managerial decisions,
managers effectively calculates the expenses and net return Purnamasari (2015, p. 80-90). It is
not a good measure for companies engaged in the production of intangible assets. Junior
managers have the power to decide the cost and outcomes according to the economic value
added by their own firms and other firms. They are able to take initiatives and plan programs

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accordingly. EVA makes the availability of capital cost to the managers and understand the
behavior of markets and which program is more effective.
2.6 Disadvantages of EVA
EVA calculation is based on the quantity of capital invested in funds, which is denoted as
a perfect measure for asset-rich companies; who have a higher market share and stability.
Moreover, EVA does not include the net present value with the flow in future cash. Only the
current level earnings are taken into consideration. Therefore, it is only effective for managers
who take on projects with quicker counts and disadvantageous for those who invests in projects
with long development periods Nakhaei, Habibollah and Hamid (2013, p. 1589-1598). EVA
provides an indication for the better performance of the business by estimating IRR, WACC and
understand the net return from the investments. Equity holders as well the lenders, invest or
borrow money depending on the WACC value. A WACC value is essential for the growth of
businesses and profits from the investments. A company does not need to encounter huge risks
from a certain investment. They can effectively calculate the net returns and analyze whether
investment will be profitable or not and then only they will invest Laszlo, Chris, and Patrick
Cescau (2017, p.114).
Although EVA has varied benefits, it is thought to mislead the wealth generation
methods. This is because EVA reflects the momentary change in the capital market instead of
inherent performance by the companies. The value added system is criticized to be biased
towards the shareholders who hold a part of their share in the business rather than the stake
holders. It is considered to be similar to residual income which has been turned down by the
firms Harrison, Jeffrey S., and Andrew (2013, p.97-124).

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3. Conclusion
EVA is useful for understanding the growth aspect of companies and their performance
in the overall markets. The policies are used to enhance the performance of the companies. These
policies are used by investors and businessman to understand their growth objectives due to the
cost and benefits of the company. A company can earn bigger profits by proper implementation
of the economic value added by firms. EVA provides an indication for the better performance of
the business by estimating the IRR and WACC and understand the net return from the
investments. Equity holders as well the lenders, invests or borrows money depending on the
WACC value. A WACC value is essential for the growth of businesses and profits from the
investments. A company does not need to encounter huge risks from a certain investment. They
can effectively calculate the net returns and analyze whether investment will be profitable or not
and then only they will invest.
Rio Tinto is a well renowned company in the world with business operations in multiple
countries. The estimated economic value added for Rio Tinto from the annual report of 2018, is
11595.86 dollars. The economic value added denotes that Rio Tinto is generating profits from
the investments. Investments have showed positive results with a huge return on the capital
investments due to their effective strategies. The high rate of return attracts more investors to
invest in the business which acts a catalyst for further growth and enhancement. It invests a great
deal of money for research and innovation of new techniques which is required to meet the rising
demands and growing needs of the society. The goal is to help economies for a faster growth and
prosperity with a commitment of the safety for the contactors, clients and communities in which
it operates. Thus, Rio Tinto has good EVA to maintain its financial state and progress towards
better growth outcome.

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4. Reference List
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Ismail, Issham. "Economic value added (EVA) versus traditional tools in predicting corporate
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Olías, Manuel, and José Nieto. "Background conditions and mining pollution throughout history
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Purnamasari, Dyah. "The effect of changes in return on assets, return on equity, and economic
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Salehi, Mahdi, Gholamreza Enayati, and Parisa Javadi. "The relationship between intellectual
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Shah, Reeta, Arunima Haldar, and S. V. D. Nageswara Rao. "Economic value added: Corporate
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