Economic Value Added

A measure of a company's economic profit by subtracting the cost of capital from operating profit

Economic Value Added (EVA) is a performance metric used to measure the true economic profit of a company or project. It goes beyond traditional profit measures like net income by considering the cost of capital invested in the business. Here's a breakdown:

Key Idea:

• Traditional profit measures don't consider the cost of using investors' money.
• EVA subtracts the cost of capital from operating profit to arrive at the economic profit, which reflects the value created for shareholders beyond just covering their required return.

Calculation:

EVA = Net Operating Profit - (Cost of Capital x Invested Capital)

Components:

• Net Operating Profit: Earnings before interest and taxes (EBIT) adjusted for non-cash items.
• Cost of Capital: The minimum rate of return investors expect on their investment (usually calculated using a weighted average of debt and equity costs).
• Invested Capital: Total assets employed in the business, less non-operating assets and current liabilities.

Interpretation:

• Positive EVA: The company is creating value for shareholders.
• Negative EVA: The company is destroying value for shareholders.
• Zero EVA: The company is just covering its cost of capital, not creating additional value.

Advantages:

• More accurate reflection of true economic profit.
• Encourages efficient use of capital.
• Useful for comparing companies across industries.

Disadvantages:

• Relies on estimates for certain values, leading to potential subjectivity.
• Can be complex to calculate and interpret.

Overall, EVA is a valuable tool for assessing a company's financial performance and its ability to create shareholder value.

Here are some additional points to consider:

• EVA is just one metric and should be used in conjunction with other financial analysis tools.
• Different approaches exist for calculating EVA, leading to potential variations in results.
• The cost of capital used in the calculation can significantly impact the EVA value.