Market value added (MVA) is a performance indicator that shows the amount by which the market value of a company exceeds the total amount of capital supplied by investors. In terms of shareholders’ wealth maximization, market value added is a very important indicator, so the higher MVA, the better.
In terms of shareholders’ wealth, market value added is the difference between the market value of common stock and the amount of common equity capital supplied by shareholders.
MVA = Market Value of Common Stock - Total Common Equity
This formula can be modified as follows:
MVA = Ns × Ps - Total Common Equity
where Ns is a number of common stock outstanding, Ps is a current common stock price, total common equity is a book value of common equity.
If a company has preferred stock outstanding, market value added available to all stockholders can be calculated as follows:
MVA = Market Value of Stock - Total Equity
MVA = Ns × Ps + Nps × Pps - Total Common Equity
where Nps is a number of preferred stock outstanding, Pps is a current preferred stock price, the total equity is a book value of equity.
Sometimes market value added can be defined as the difference between the total market value of a company and capital supplied by all investors (both shareholders and debtholders).
MVA = Total Market Value - Invested Capital
MVA = Market Value of Stock + MVA + Market Value of Debt - Invested Capital
As was shown above, the market value of a stock can be easily calculated, but sometimes the market value of debt is not easy to define, so many academic studies recommend using the book value of debt instead.
Calculation of invested capital is rather complicated, so follow these guidelines.
XYZ Company has 3,970,000 shares of common stock outstanding at a current market price of $7.83. The company’s long-term debt is represented by a bond issue with a fixed annual coupon rate of 12.75%. This bond issue will mature in the next 3 years, and the current required rate of return on bonds with a similar risk is 14.25%.
Balance sheet, US $ in thousands
In terms of shareholders’ wealth, the market value added is $5,605,100.
MVA = 3,970,000 × $7.83 - $25,480,000 = $5,605,100
However, to appraise the market value added available for all investors, we need to find the market value of debt and invested capital.
Many academic studies recommend using the book value of short-term debt as its market value. The point of such an approach is that interest rates usually don’t change dramatically in a short-term period (less than 1 year).
In a long-term run (more than 1 year), however, interest rates can shift significantly, so using the long-term debt’s market value is preferable to its book value. To find the market value of bonds, we simply need to calculate their present value. The expected coupon payment at the end of each year is $892,500 ($7,000,000 × 12.75%), and the principal payment to be made at the end of the third year is $7,000,000. If the current required rate of return of 14.25% is applied, the present value of the bonds will be $6,757,247.60.
|PV =||$892,500||+||$892,500||+||$892,500 + $7,000,000||= $6,757,247.60|
|(1 + 0.1425)1||(1 + 0.1425)2||(1 + 0.1425)3|
We can’t appraise the market value of other long-term liabilities, so their book value of $550,000 will be used.
To get the final number of invested capital, the guidelines mentioned above were used.
Invested capital = $13,060,000 - ($5,680,000 + $1,890,000 + $1,230,000) + $34,200,000 - $800,000 = $37,660,000
Thus, the market value added available for all investors is $5,362,347.60.
MVA = ($3,970,000 × $7.83 + $4,630,000 + $6,757,247.60 + $550,000) - $37,660,000 = $5,362,347.60
The main advantage of market value added as a performance indicator is that it can be easily calculated if a company’s stocks are regularly traded on a stock exchange. If a company’s stocks are traded in the over-the-counter (OTC) market and the number of trades is low and irregular, using MVA is not recommended.
Beware that even if a company is publicly traded on an established stock exchange, the change in stock price can reflect the change in investors’ confidence in the economy as a whole or in the industry rather than in company performance!