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Economic Value Added: EVA Is An Estimate of A Firm's Economic Profit - Being
Economic Value Added: EVA Is An Estimate of A Firm's Economic Profit - Being
EVA is Net Operating Profit After Taxes (or NOPAT) less the money cost of capital.
Any value obtained by employees of the company or by product users is not
included in the calculations. The basic formula is:
EVA=(r-c)*k=NOPAT-c*k
where:
“r”=NOPAT/K ,is the Return on Invested Capital (ROIC);
“c” is the Weighted Average Cost of Capital (WACC);
“k” is capital employed;
NOPAT is the Net Operating Profit After Tax, with adjustments and translations for
the amortization of goodwill, the capitalization of brand advertising and others.
EVA Calculation
EVA = (r-c) x Capital
EVA = (r x Capital) – (c x Capital)
EVA = (NOPAT- c x Capital
EVA = operating profits – a capital charge
NOPAT:
NOPAT is profits derived from a company’s operations after taxes
but before financing costs and noncash-bookkeeping entries. It is
the total pool of profits available to provide a cash return to those
who provide capital to the firm.
Capital is the amount of cash invested in the business, net of
depreciation
Capital charge is the cash flow required to compensate investors
for the riskiness of the business given the amount of capital
invested
The cost of capital is the minimum rate of return on capital required
to compensate debt and equity investors for bearing risk.
EVA can be found from a firm’s RETURN ON NET
ASSETS(RONA).It is RONA = NOPAT/Capital(after making
necessary adjustments of the data according to financial
accounting system).EVA =net investments*(RONA-minimum
requirements).if RONA is above the threshold rate ,EVA is positive.
SUMMARY
EVA is a method to measure a
company’s true profitability and to steer
the company correctly from the point of
shareholders.
It improves profitability usually through
improved capital turnover.
EVA is at its best integrated in incentive
system.
USES
Setting organizational goals
Performance measurement
Capital budgeting
Determining bonuses
Motivation of the managers
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