Economic Value Added (EVA)

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Definition: Economic Value Added (EVA)

Economic value added (EVA) in the simplest terms is the operating profit in excess of the cost of capital. Economic value added (EVA) gives a measure of the value created by the company after adjusting for the cost of financing i.e. the cost of raising capital via debt, equity or other means. Economic value added is the contrast between the profit made by a company from the capital contributed or invested and the cash paid to get that capital. That implies it is the proportion of the amount more the organization has made than the required return of its investors. It is otherwise called economic profit.


Importance of Economic Value Added (EVA)

Economic value added gives the financial position of a company. Based on EVA values, the following can be understood:

1. If EVA is negative: Company is not making so much profit that it can look after its investor’s wealth. In this case the company must do a check on all the areas of the company to figure out which territories are neglecting to make higher estimation of EVA. If EVA still continues to be negative then the company should shut down.

2. If EVA is positive: Company is doing good. It is making more money than required return.

EVA measures the performance of an organisation over period. It tells us how profitable a company is or its projects are. It also tells whether the company is creating any wealth for its investors or not. It reveals how much and from where the company created wealth. It includes balance sheet in the calculation so the managers make choices taking assets into consideration and not just expenses. Unlike Market value added which is done for entire company, Economic value added can be done within the company like for a specific division or product offering. It depends intensely on invested capital so it is mostly applicable to asset-intensive companies, companies having tangible assets like automobile company than companies having intangible assets like software companies. Another similar concept is market value added (MVA).

Economic Value Added (EVA)


Formula for Economic Value Added (EVA)

The formula for economic value added (EVA) is given as:

EVA = NOPAT- WACC*Capital


Where:

EVA : Economic Value added

NOPAT: Net Operating Profit After Tax = EBIT(1-T); EBIT : Earnings before interests and taxes, T:Tax rate

WACC : Weighted average cost of capital


WACC Formula:

WACC = wd*rd*(1-T)+we*re

Where:

wd: weight of debt in a combination of debt and equity = debt/(debt + equity)

rd: Return on the debt

we: weight of equity in a combination of debt and equity = equity/(debt+equity)

re: Return on the equity


Economic Value Added (EVA) Example

Refer to the example below:

Revenues

1000000

Cost of goods sold (COGS)

600000

EBIT

400000

NOPAT= EBIT(1-T); T=40%

240000

WACC

10%

Capital

1100000

WACC*Capital

110000

EVA

130000


Hence, this concludes the definition of Economic Value Added (EVA) along with its overview.

Browse the definition and meaning of more terms similar to Economic Value Added (EVA). The Management Dictionary covers over 7000 business concepts from 6 categories.

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