Economic value added

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In corporate finance, Economic Value Added or EVA is an estimate of true economic profit after making corrective adjustments to GAAP accounting, including deducting the opportunity cost of equity capital. EVA can be measured as Net Operating Profit After Taxes(or NOPAT) less the money cost of capital. EVA is similar in nature to that of calculating another financial performance measure - Residual Income (RI), however, there are a few complexities involved with coming up with the elements for calculating EVA over RI such as the myriad adjustments that might be made to NOPAT before it is suitable for the formula below. In both cases, money cost of capital refers to the amount of money rather than the proportional rate (% cost of capital). The amortization of goodwill or capitalization of brand advertising and other similar adjustments are the translations that occur to Economic Profit to make it EVA. The EVA is a registered trademark by its developer, Stern Stewart & Co.

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[edit] Calculating EVA

In the field of corporate finance, economic values added is a way to determine the value created, above the required return, for the shareholders of a company.

The basic formula is:

\mathit{EVA} \ = \ ( r - c ) \cdot K \ = \ \mathit{NOPAT} - c \cdot K

where

r = { \mathit{NOPAT} \over K } , called the Return on Invested Capital (ROIC).

is the firm's return on capital, NOPAT is the Net Operating Profit After Tax, c is the Weighted Average Cost of Capital (WACC) and K is capital employed.

Shareholders of the company will receive a positive value added when the return from the capital employed in the business operations is greater than the cost of that capital; see Working capital management. Any value obtained by employees of the company or by product users is not included in the calculations.

[edit] Relationship to Market Value Added

The firm's market value added, or MVA, is the discounted sum of all future expected economic value added:

MVA = V - K_0 = \sum_{t=1}^{\infty} { EVA_t \over (1+c)^t }

Note that MVA = NPV of company.

[edit] Criticism

  • EVA is also shareholder-centric and hence of little relevance to the rest of the stake holders.[citation needed]
  • EVA is identical to residual income, which was largely abandoned by US companies years ago (Keys, Azamhuzjaev, and Mackey, 2001).

[edit] Other measures of shareholder value

[edit] See also

[edit] References

  • G. Bennett Stewart III (1991). The Quest for Value. HarperCollins. 
  • Erik Stern. The Value Mindset. Wiley. 
  • Joel Stern and John Shiely. The EVA Challenge. Wiley. 
  • Al Ehrbar. EVA, the Real Key to Creating Wealth. Wiley. 

[edit] External links

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