Economic Value Added (EVA): Definition, Formula, Example, Calculation, Meaning

Follow us on LinkedIn

The economic profit of a company tells us the true economic value of a company, which is why EVA has become popular among investors and owners of companies.

It helps to show the financial performance of a business by taking into account both its costs of capital and taxes.

Add your business to our business directory https://harbourfronts.com/directory/ Add your business. Also check out other businesses in the directory

Companies that generate higher EVAs are considered to have better economic profits compared to their peers, as they have been able to generate higher revenues than their costs of capital and taxes.

EVA can be used to compare the performance of different companies in the same industry, or even against competitors in other industries.

What is Economic Value Added or EVA?

EVA is the difference between a company’s operating profit and its cost of capital, adjusted for taxes on a cash basis. It is an indication of the true economic value added by that company to its shareholders.

A company with a higher EVA than its peers indicates that it has been able to generate more revenue than what was used to finance its operations and pay taxes.

This creates value for shareholders, which is why EVA is an important metric to consider when evaluating a company’s financial performance.

In addition to providing investors with insight into the true economic profit of a company, EVA can also be used as a metric to motivate management to make better decisions that maximize the value of their business.

By setting EVA targets, companies can create incentives for managers to drive more profitable decisions and strive for higher levels of value generation.

How EVA Works

EVA (Economic Value Added) is a metric used to assess the added value generated by a company due to investments made.

It measures the incremental difference between a firm’s rate of return on its invested capital and its cost of capital, thus providing insight into how well an organization manages and utilizes funds for growth.

When a company’s EVA is negative, it means the investment funds are not being utilized to their fullest potential. A positive EVA, on the other hand, proves that those same investments are driving value into the business and generating profit.

It gives an accurate indication of the company’s true economic performance.

EVA is not only a helpful metric for investors but it can also be used to motivate management and reward employees for driving value into their business.

By setting EVA targets, companies can create incentives for managers to drive more profitable decisions and strive for higher levels of value generation.

How to Calculate EVA

Here is the formula for calculating EVA

EVA = NOPAT – (Invested Capital * WACC)

Where,

NOPAT or Net Operating Profit After Tax: This is the company’s operating profit after taxes are taken into account.

Invested Capital: This is the total amount of capital invested in the business, including equity and debt financing.

WACC or Weighted Average Cost of Capital: This is the rate of return that a company must earn to compensate its investors for their investments in the firm. It is the average of the cost of equity and debt financing, weighted by their respective proportions in the capital structure.

Example of EVA

Let’s take the example of ABC Company. The company has an operating profit (NOPAT) of $100 million and invested capital of $500 million with a weighted average cost of capital (WACC) of 8%.

The EVA for ABC Company would be calculated as follows

EVA = 100 – (500 * 0.08)

= 100 – 40

= $60 million

Therefore, the EVA for ABC Company is $60 million. This indicates that the company has generated an economic profit of $60 million above and beyond its cost of capital.

Conclusion

In conclusion, Economic Value Added (EVA) is a useful metric for investors as it provides an accurate indication of a company’s true economic performance. It measures the difference between a firm’s rate of return on its invested capital and its cost of capital, thus providing insight into how well an organization manages and utilizes funds for growth.

Further questions

What's your question? Ask it in the discussion forum

Have an answer to the questions below? Post it here or in the forum

LATEST NEWSAn alliance of Myanmar ethnic groups claim capture of another big trade crossing at Chinese border
An alliance of Myanmar ethnic groups claim capture of another big trade crossing at Chinese border

BANGKOK (AP) — An alliance of armed ethnic minority groups that launched a surprise offensive last month against Myanmar’s military has seized a major trading gate on the country’s northeastern border with China, a spokesperson for one of the groups said Sunday. Le Kyar Win,…

Stay up-to-date with the latest news - click here
LATEST NEWSRussia puts spokesman for tech giant and Facebook owner Meta on wanted list
Russia puts spokesman for tech giant and Facebook owner Meta on wanted list

Russia has added the spokesman of U.S. tech giant Meta, which owns Facebook and Instagram, to a wanted list, according to an online database maintained by the country’s interior ministry. Russian state agency Tass and independent news outlet Mediazona first reported on Andy Stone’s inclusion…

Stay up-to-date with the latest news - click here
LATEST NEWSLeesa Cyber Monday sales: Score up to $775 off plus free accessories
Leesa Cyber Monday sales: Score up to $775 off plus free accessories

Leesa's Cyber Monday deals include up to $400 off our favorite mattress, the Leesa Sapira Hybrid. Our exclusive code will save you even more.

Stay up-to-date with the latest news - click here
LATEST NEWSAmerican girl, 4, freed as Hamas hands over more Israeli, Thai hostages
American girl, 4, freed as Hamas hands over more Israeli, Thai hostages
Stay up-to-date with the latest news - click here
LATEST NEWS‘Enjoy sub-$40K Bitcoin’ — PlanB stresses $100K average BTC price from 2024
‘Enjoy sub-$40K Bitcoin’ — PlanB stresses $100K average BTC price from 2024
Stay up-to-date with the latest news - click here

Leave a Reply