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.
This formula can be modified as follows:
where 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:
where 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).
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.
Market value added calculation example
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%. The reported balance sheet is as follows:
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 $892.5K ($7,000K*12.75%), and the principal payment to be made at the end of the third year is $7,000 thousands. If the current required rate of return of 14.25% is applied, the present value of the bonds will be $6,757.25K.
We can’t appraise the market value of other long-term liabilities, so their book value of $550K will be used.
To get the final number of invested capital, the guidelines mentioned above were used.
Invested capital = 13,060-(5,680+1,890+1,230)+34,200-800 = $37,660K
Thus, the market value added available for all investors is $5,362,350.
MVA = (3,970,000*$7.83 + $4,630,000 + $6,757,250 + $550,000) – $37,660,000 = $5,362,350
Advantages and disadvantages
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!