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    Understanding Economic Value Added

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    Prashant Sharma
    EVA is a measure of a company's financial performance based on the net operating profit after tax minus a charge for the cost of capital used to generate profits. A positive EVA means the company's return exceeded the required rate of return, while a negative EVA means the return did not cover the cost of capital. EVA is calculated as NOPAT - (Invested Capital x WACC), where NOPAT is net operating profit after tax, invested capital is total assets minus current liabilities, and WACC is the weighted average cost of capital. EVA is useful for evaluating management performance but relies heavily on invested capital levels and may not be suitable for assessing companies with significant intangible assets.

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    Understanding Economic Value Added

    Uploaded by

    Prashant Sharma
    27 views2 pages
    EVA is a measure of a company's financial performance based on the net operating profit after tax minus a charge for the cost of capital used to generate profits. A positive EVA means the company's return exceeded the required rate of return, while a negative EVA means the return did not cover the cost of capital. EVA is calculated as NOPAT - (Invested Capital x WACC), where NOPAT is net operating profit after tax, invested capital is total assets minus current liabilities, and WACC is the weighted average cost of capital. EVA is useful for evaluating management performance but relies heavily on invested capital levels and may not be suitable for assessing companies with significant intangible assets.

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    EVA is a measure of a company's financial performance based on the net operating profit after tax minus a charge for the cost of capital used to generate profits. A positive EVA means the company's return exceeded the required rate of return, while a negative EVA means the return did not cover the cost of capital. EVA is calculated as NOPAT - (Invested Capital x WACC), where NOPAT is net operating profit after tax, invested capital is total assets minus current liabilities, and WACC is the weighted average cost of capital. EVA is useful for evaluating management performance but relies heavily on invested capital levels and may not be suitable for assessing companies with significant intangible assets.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    27 views2 pages

    Understanding Economic Value Added

    Uploaded by

    Prashant Sharma
    EVA is a measure of a company's financial performance based on the net operating profit after tax minus a charge for the cost of capital used to generate profits. A positive EVA means the company's return exceeded the required rate of return, while a negative EVA means the return did not cover the cost of capital. EVA is calculated as NOPAT - (Invested Capital x WACC), where NOPAT is net operating profit after tax, invested capital is total assets minus current liabilities, and WACC is the weighted average cost of capital. EVA is useful for evaluating management performance but relies heavily on invested capital levels and may not be suitable for assessing companies with significant intangible assets.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
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    Economic Value Added (EVA)

    EVA is the incremental difference in the rate of return (RoR) over a


    company's cost of capital. Essentially, it is used to measure the value a
    company generates from funds invested in it. If a company's EVA is
    negative, it means the company is not generating value from the funds
    invested into the business. Conversely, a positive EVA shows a company
    is producing value from the funds invested in it.

    The formula for calculating EVA is:

    EVA = NOPAT - (Invested Capital * WACC)

    Where:

    • NOPAT = Net operating profit after taxes


    • Invested capital = Debt + capital leases + shareholders' equity
    • WACC = Weighted average cost of capital

    Special Considerations
    The equation for EVA shows that there are three key components to a
    company's EVA—NOPAT, the amount of capital invested, and the WACC.
    NOPAT can be calculated manually but is normally listed in a public
    company's financials.

    Capital invested is the amount of money used to fund a company or a


    specific project. WACC is the average rate of return a company expects to
    pay its investors; the weights are derived as a fraction of each financial
    source in a company's capital structure. WACC can also be calculated but
    is normally provided.

    The equation used for invested capital in EVA is usually total assets minus
    current liabilities—two figures easily found on a firm's balance sheet. In
    this case, the modified formula for EVA is NOPAT - (total assets - current
    liabilities) * WACC.

    As noted by Stern Value Management, in 1983 the management team


    developed EVA, "a new model for maximizing the value created that can
    also be used to provide incentives at all levels of the firm."1 The goal of
    EVA is to quantify the cost of investing capital into a certain project or firm
    and then assess whether it generates enough cash to be considered a
    good investment. A positive EVA shows a project is generating returns in
    excess of the required minimum return.
    Advantages and Disadvantages of EVA
    EVA assesses the performance of a company and its management
    through the idea that a business is only profitable when it creates wealth
    and returns for shareholders, thus requiring performance above a
    company's cost of capital.

    EVA as a performance indicator is very useful. The calculation shows how


    and where a company created wealth, through the inclusion of balance
    sheet items. This forces managers to be aware of assets and expenses
    when making managerial decisions.

    However, the EVA calculation relies heavily on the amount of invested


    capital and is best used for asset-rich companies that are stable or mature.
    Companies with intangible assets, such as technology businesses, may
    not be good candidates for an EVA evaluation.

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