Economic value added

Economic Value Added

Economic Value Added

Economic Value Added (EVA) is a financial performance measure that evaluates the profitability of a company by calculating the value it generates above its cost of capital. It is a concept developed by Stern Stewart & Co., a consulting firm, and has gained significant popularity among financial analysts and investors.

Calculation

The calculation of Economic Value Added involves subtracting the company's cost of capital from its net operating profit after tax (NOPAT). The cost of capital is the minimum return required by investors to compensate for the risk associated with investing in the company. The formula for calculating EVA is as follows:

EVA = NOPAT - (Capital * Cost of Capital)

Where: - NOPAT is the net operating profit after tax - Capital refers to the total capital employed by the company - Cost of Capital is the weighted average cost of capital (WACC)

Significance

EVA provides a comprehensive measure of a company's financial performance by considering both its profitability and the cost of capital. It helps in determining whether a company is creating value for its shareholders or not. A positive EVA indicates that the company is generating returns above its cost of capital, while a negative EVA suggests that the company is not meeting the required return expectations.

Application

EVA is widely used by financial analysts and investors to assess the performance of companies. It helps in comparing the financial performance of different companies within the same industry or across industries. By analyzing the EVA of a company over time, investors can evaluate its ability to consistently create value.

Criticisms

While EVA is a popular financial performance measure, it has also faced criticism. Some argue that it is a complex metric that may not accurately reflect the true value created by a company. Additionally, the calculation of EVA involves several assumptions and estimates, which can introduce subjectivity and potential biases.

Conclusion

Economic Value Added is a useful financial performance measure that provides insights into a company's ability to generate value above its cost of capital. It helps in evaluating the profitability and efficiency of a company, making it a valuable tool for financial analysis and investment decision-making.

See Also

• Financial Performance
• Return on Investment
• Weighted Average Cost of Capital