Market value added definition
/What is Market Value Added?
The market value added concept derives the difference between the market value of a business and the cost of the capital invested in it. When market value is less than the cost of invested capital, this implies that management has not done a good job of creating value with the equity made available to it by investors. Conversely, when market value is greater than the cost of invested capital, it indicates that company operations are well run.
Advantages of Market Value Added
A business that reports a high level of market value added can be a good choice for investors, because it shows that the management team is tightly focused on making efficient use of shareholder capital. It also indicates that management is good at developing products and services that generate above-average amounts of profit and cash flow - both of which enhance the value of the firm’s equity.
Disadvantages of Market Value Added
The market value added measurement is derived from the market price of a company’s stock. If the stock market is experiencing a strong bull run, stock prices may have increased, irrespective of the efforts of the firm’s management team. That is, the managers might have quite modest skills that are not really enhancing the business, and yet the market is boosting the company’s stock. The result is a high MVA figure even though it is not deserved.
Related AccountingTools Courses
The Interpretation of Financial Statements
How to Calculate Market Value Added
To derive market value added, follow these steps:
Multiply the total of all common shares outstanding by their market price
Multiply the total of all preferred shares outstanding by their market price
Combine these totals
Subtract the amount of capital invested in the business
The formula is:
(Number of common shares outstanding x share price) + (Number of preferred shares outstanding x share price)
- Book value of invested capital
This measurement should only be used if a company's stock is robustly traded on an established stock exchange. Otherwise, a few occasional trades in the over-the-counter market could trigger substantial changes in the market price of the stock, which massively alters the outcome of the calculation. It may be possible to derive the market value of shares by engaging an appraiser to provide an estimate, especially if a company is privately-held.
Also, be aware that the current stock price may be based on changes in investor confidence in the market or industry as a whole, and do not relate to the performance (or lack thereof) of management in running a business.
Example of Market Value Added
As an example, the investor relations officer of Cud Farms is preparing a press release that reveals the increase in market value added since the new management team was hired. The analysis is based on the following information:
The market value added for the prior year is calculated as follows:
(5,000,000 Common shares x $4.00 price) + (400,000 Preferred shares x $11.00 price) - $18,000,000 Equity book value
= $6,400,000 Market value added
The market value added for the current year is calculated as follows::
(5,700,000 Common shares x $4.20 price) + (375,000 Preferred shares x $11.30 price) - $20,625,000 Equity book value
= $7,552,500 Market value added
Based on this analysis, the investor relations officer can highlight an increase of $1,152,500 in market value added since the new management team was hired.