What Is Economic Value Added?

What Is Economic Value Added?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

Economic Value Added (EVA) is a metric that calculates the true economic profit of a company. It does this by measuring the company’s net operating profit after tax, then deducting the capital costs, including the cost of equity. By doing this, EVA shows whether a business is performing in a way that increases shareholder value. This calculation makes it a useful tool in assessing a company’s economic performance and encourages managers to think like shareholders.

Related Questions

1. How is EVA calculated?

Economic Value Added is calculated by subtracting a company’s capital cost from its Net Operating Profit After Taxes (NOPAT). So, EVA = NOPAT – Capital Cost.

2. Why is EVA important?

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EVA is an important metric because it provides a clear, quantifiable measure of a company’s profitability. It factors in the company’s operating profit and also accounts for the cost of capital, providing a more complete understanding of the company’s true economic profit.

3. What does a positive EVA indicate?

A positive EVA indicates that a company is generating more than the required minimum return for its investors. In other words, the company is creating wealth for its shareholders, which is a positive sign of its performance and efficiency.

4. How does EVA differ from traditional financial performance measures?

Unlike traditional financial measures like net income or earnings per share, EVA considers the cost of capital, making it a more comprehensive measure of profitability. Traditional measures merely focus on earnings, whereas EVA reveals if those earnings are sufficient given the cost of capital.

5. Can EVA be negative and what does that mean?

Yes, EVA can be negative. A negative EVA means that the company is not generating enough return to cover the cost of capital, indicating it is not effectively creating wealth for its shareholders. This can signal potential financial problems in the company.