Economic Value Added (EVA)
Economic Value Added, or EVA, is a financial metric that measures a company’s financial performance by calculating the difference between the company’s net operating profit after tax (NOPAT) and the cost of capital. In other words, EVA is the amount of value a company has created for its shareholders after accounting for the cost of financing the company’s operations.
EVA is calculated using the following formula:
EVA = NOPAT – (Capital * Cost of Capital)
Where NOPAT is the company’s net operating profit after tax, Capital is the total capital employed by the company, and Cost of Capital is the company’s weighted average cost of capital (WACC).
For example, if a company has a NOPAT of $1 million, total capital of $5 million, and a WACC of 10%, the EVA would be calculated as follows:
EVA = $1 million – ($5 million * 0.10) = $500,000
In this example, the company has created $500,000 of economic value for its shareholders.
Benefits of EVA
There are several benefits to using EVA as a financial metric. EVA aligns the interests of shareholders and management by focusing on value creation rather than just profit. It also provides a more accurate measure of a company’s true economic profitability by subtracting the cost of capital from profits. Additionally, EVA can help identify areas where a company is underperforming and guide strategic decision-making.
Conclusion
Economic Value Added is a valuable tool for evaluating a company’s financial performance and assessing its ability to create value for shareholders. By calculating EVA, companies can better understand their true economic profitability and make informed decisions to improve their financial performance.
For more information on Economic Value Added, visit Wikipedia.