Management

It is generally believed that in order to maximise value for shareholders, companies should strive towards maximising MVA (and not necessarily their total market value). The best way to do so is to maximise the EVA, which reflects an organisation’s ability to earn returns above the cost of capital. The leverage available to companies that incur fixed costs and use borrowed capital with a fixed interest charge has been known and quanti-fied by financial managers for some time. The popularisation of EVA and MVA has opened up new possibilities for investigating the leverage effect of fixed costs (operational leverage) and interest (financial leverage) in conjunction with EVA and MVA, and for determining what effect changes in sales would have through leverage, not only on profits, but also on EVA and MVA. Combining a variable costing approach with leverage analysis and value analysis opens up new opportunities to investigate the effect of certain decisions on the MVA and the share price of a company. A spread-sheet model is used to illustrate how financial managers can use the lever-age effects of fixed costs and the (fixed) cost of capital to maximise profits and also to determine what impact changes in any variable like sales or costs will have on the wealth of shareholders. Key words Economic Value Added (EVA) Total degree of leverage (TDL) Market Value Added (MVA) EVA leverage Degree of operating leverage (DOL) Total leverage including EVA Degree of financial leverage (DFL) Weighted average cost of capital (WACC) The relationship between EVA, MVA and leverage 40 Meditari Accountancy Research Vol. 12 No. 1 2004: 39–59