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## Calculation of the true economic profit of a corporation. Explanation of Economic Value Added. EVA.

 Contents

### What is EVA? Definition

Economic Value Added (EVA) is a financial performance method to calculate the true economic profit of a corporation. EVA can be calculated as Net Operating Profit After Tax minus a charge for the opportunity cost of the capital invested.

EVA ( © / ™ Stern Stewart & Co.) is an estimate of the amount that earnings differ from the required minimum rate of return (against comparable risk) for shareholders or lenders. The difference can be both a surplus or a shortage.

### EVA compared with MVA

Unlike Market-based measurements, such as MVA, EVA can be calculated for a divisional (Strategic Business Unit) level.

Unlike Equities measurements, EVA is a flow and can be used for performance evaluation over time.

### EVA compared with EBIT and EPS

Unlike accounting profit, such as EBIT, Net Income and EPS, EVA is economic and is based on the idea that a company must cover both the operating costs AND the capital costs.

### Calculation of EVA. Formula

The basic formula for calculating EVA is:

Net Sales

-     Operating Expenses

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Operating Profit (EBIT)

-     Taxes

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Net Operating Profit After Tax (NOPAT)

-     Capital Charges (Invested Capital x Cost of Capital)

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By taking all capital costs into account, including the cost of equity, EVA shows the financial amount of wealth a business has created or destroyed in a reporting period. In other words, EVA is profit in the way that shareholders define it. If the shareholders expect, say, a 10% return on their investment, they earn money only to the extent that their share of the NOPAT exceeds 10% of equity capital. Everything before that just builds up to the minimum acceptable compensation for investing in a risky enterprise.

### USAGE of the EVA method: Aligning decisions with shareholder wealth

EVA was developed to help managers to incorporate two basic principles of finance into their decision making:

1. The primary financial objective of any company should be to maximize the wealth of its shareholders.
2. The value of a company depends on the extent to which investors expect that future profits will differ from the cost of capital. By definition, a sustained increase in EVA will result in an increase in the market value of a company. This approach has proved valid and effective for many types of organizations. This is because the level of EVA isn't what really matters. Current performance already is reflected in share prices. It is the (continuous) improvement in EVA that brings (continuous) increases in shareholder wealth.

Some specific usages of EVA include:

• To set organizational goals.
• Performance measurement.
• Determining of bonuses.
• Communication with shareholders and investors.
• Motivation of managers.
• Capital budgeting.
• Corporate valuation.
• Analyzing equities.

Book: S. David Young, Stephen F. O'Byrne - EVA and Value-Based Management.. -

Book: Aswath Damodaran - Investment Valuation: Tools and Techniques for Determining.. -

Book: James R. Hitchner - Financial Valuation: Applications and Models -

 What is EVA Momentum? EVA Momentum is the change in a business's EVA divided by the prior period's sales (revenue). It was developed by Bennet Stewart of EVA Dimensions. It is an application of EVA that measures the EVA growth rate, scaled to the size of the company. ...
 What is the Impact of Debt on EVA? What is the impact debt is having on EVA? Thanks for your help....
 Revised Economic Value Added (REVA) What is the difference between EVA and Adjusted or Revised Economic Value Added (REVA)? And how can it be calculated? Thank you all.....
 EVA for Corporate Incentives Is EVA a good metric to determine incentive compensation awards at the corporate level? Why?...
 How to Calculate EVA Another way to describe how to calculate EVA: Economic Value Added = NOPAT - Capital Charges or Economic Value Added = NOPAT - ( Invested Capital * WACC ) or Ec...
 EVA Calculation across a Whole Value Chain I request to all members to help me on how to go about an EVA calculation across the value chain from production down to consumption. What is important to keep in mind?...
 Calculating EVA for a Proprietary Company EVA can be easily calculated when the organisation is Public Limited. But it is difficult to calculate EVA of a proprietary company as the cost of equity does not exist. Please advise me....
 EVA applied to consulting services How can I apply an EVA model to the value added of consulting services on increased revenues....
 EVA & Amortization of R&D The amortization of R&D on straight line basis does not justify the concept of equal opportunity through out the life of amortization and it seems to be more biased towards the earlier years of product. We know that companies get maximum benefits fro...
 Alternative Methods for Economic Value Added (EVA) Are there alternative methods for EVA? I am developing a research study, comparing some valuation methods. I am not concerned about asset valuation, but with value creation. I found TBR, only, does anyone know other ones? Thank you all....
 EVA growth is what matters Improving EVA should be the goal of any major firm. After all, shareholders, who are providing the capital for the firm, have options to invest money elsewhere. To keep them onboard, managers must focus on growing the business when the returns...
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 Economic Value Added Special Interest Group
 Economic Value Added Education & Events

 Weaknesses of EVA Based on their findings from their survey of Fortune 1000 companies, Prakash Deo and Tarun Mukherjee summarized following weaknesses of EVA in below m... Usage (application): Value Based Management Benefits of EVA According to the article “How Fortune 1000 Firms View EVA” by Prakash Deo and Tarun Mukherjee (Corporate Finance Review, Sep/Oct 2009), EVA has follwi... Usage (application): Value Based Management EVA Advantages Economic Value Added has improved the corporate finance techniques and nowadays it represents the most modern management system based on EVA and Market Value EVA has been pointed out as the most accurate management system focused on value creation. Unlike MVA, that is strongly link... Usage (application): Management Control of Value Drivers. The Accounting Adjustments to EBIT Before Calculating EVA In order to improve the measurement of Economic Value Added and to eliminate falsifications due to differences in the application of accounting standa... Usage (application): Value Based Management, Economic Value Added