Enhancing Shareholder Value
In 1995-96, Infosys began to prepare its financial statements in compliance with the Generally Accepted Accounting Principles(GAAP) of the US and Securities Exchange Commission (SEC) disclosure norms. The 1995-96 annual report provided additional information to its share holders on Human Resources Accounting, and by way of Value Added and Economic Value Added (EVA) statements.
The annual report of HLL for the year ending December 1996, while providing additional information to share holders, has stated that the traditional approaches like the market capitalisation approach, earnings capitalisation and present value of estimated cash flows of measuring share holders value have become obsolete. What is important now is not earnings per share but value. Hence HLL has also provided the statement computing the EVA.
EVA is calculated by subtracting the cost of capital employed from the net operating profits after depreciation and taxes but before interest costs. The cost of capital includes cost of debt and cost of equity.
Cost of debt is taken net of taxes at the effective interest rate applicable to `AAA rated companies like HLL with an appropriate mix of short, medium and long term debt.
The way of computing cost of equity is by way of a unique formula: Return on risk-free investment plus expected risk premium on equity investment adjusted for the Beta variant of the companys scrip is taken to be the cost of equity.
EVA of Infosys increased substantially from Rs 9.41 lakh in 1995-96 to Rs 5.85 crore in 1996-97. The phenomenal increase is because the company brought down its debt funding to zero.
In the case of HLL, EVA has risen from Rs 119 crore in 1995-96 to Rs 239 crore last year.
However, Infosys has added further value in its latest annual report for the year 1996-97. The company has done a brand valuation for `Infosys.
Infosys has used the generic Brand-Earnings Multiple model for evaluation. In this model, the brand earning is determined initially which is done by calculating the profits on that particular brand. Later, it is added to the historical profits of the brand restated at present day value. Dividing this amount by the cost of capital employed to produce the product and adjusting for taxes will give the brand earnings.
Later, the brand strength or brand earning multiple is determined based on the ranking of Infosys in the software industry. This ranking is based on a number of factors like leadership, stability, internationality etc.
The total brand value is determined by multiplying these two variables--brand earnings and brand earning multiple.
After this exercise, the brand value of Infosys was estimated to be Rs 172.83 crore at the end of 1996-97.
In the future, one should be seeing many companies coming out with such clean and transparent ways of accounting in order to get a better discounting in the market.