Prospective Accounting Initiative 

Appendix 8

A Comparison of AFTF with EVA^TM 

EVA^TM is a fine and useful management tool and has been extremely valuable in highlighting the need for measures that take the cost of capital into account. In the comparison that follows, AFTF (DVA) may seem superior, but read "The Valuation Contest" chapter of The Quest for Value for an alternative view. The purpose of this comparison is to elucidate both approaches and to contrast them. 

The EVA^TM approach "… yields the same answer for a given forecast that discounting cash flow yields …". It may not be surprising to note that the same cash flow forecast is required for both approaches and that, despite initial appearances, EVA^TM is not easier for valuation. It is also not easier for value-added calculations. There are certain aspects of AFTF that are more direct or simpler.

EVA^TM is designed as a management tool and is primarily designed to provide measures of value added. AFTF is designed as a financial reporting tool and is primarily designed to provide measures of value. AFTF is very strictly disciplined. 

EVA^TM is phrased as a complex adjustment to traditional accounting for the past year. AFTF is directly phrased as the present value of all future expected cash flows. It does not move cash flows between years, a problem with EVA^TM as well as traditional accounting. 

EVA^TM is "… the only measure to tie directly to intrinsic market value."; the words "only" and "directly" are sales talk. AFTF is phrased directly in market values terms, but does not duplicate the market value and may not precisely duplicate the "intrinsic market value". 

EVA^TM is "consistent with the standard budgeting rule"; this is a stretch. AFTF uses the capital budgeting technique. 

EVA^TM does not take the investment cash flow directly into account. Instead it capitalizes it and subtracts interest annually on the original amount of the investment. The present value of these interest subtractions, at the same interest rate, is the original amount of the investment. Under AFTF the original investment amount is a cash flow occurring at the time the investment is made. Note that it is not necessary to determine any past investment amounts, since AFTF is purely prospective. Nor is it necessary to explicitly subtract depreciation or interest. The present value automatically does this. 

EVA^TM requires that the cost of equity capital and the equity both be elaborately estimated. AFTF relates the cost of capital to capital market pricing. AFTF also gives credibility to the market valuations in determining the historic shareholders’ equity. 

EVA^TM adds the after tax cost of debt capital to the net operating profit so that it along with the cost of equity capital may be subtracted as a single item. AFTF considers debt from the same perspective as any other investment decision. Only the cost of equity capital is used as a discount rate. This is believed to maximize shareholder gain and thereby provide a proper basis for management decisions. 

EVA^TM, by its own claim, is equivalent to AFTF (Discounted cash flows). However, EVA^TM is less straightforward. AFTF is an extension of recent accounting developments, especially the ECF and entity-specific concepts. In addition, it provides a motivated and vital discipline to the valuation process. 

With EVA^TM you may have to already be in trouble before EVA^TM delivers its message. AFTF anticipates future years so that a line of business will be profitable as long as the AFTF equity is positive. AFTF is preventative medicine. EVA^TM is the autopsy. 

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