Economic value added (EVA) is a measure of a company’s financial performance that aims to calculate the true economic profit generated by the company. It is used to measure the value a company generates from the funds invested in it. EVA is calculated by subtracting the company’s cost of capital from its operating profit, adjusted for taxes on a cash basis.
Key Facts
- EVA is a measure of a company’s financial performance that aims to calculate the true economic profit generated by the company.
- It is used to measure the value a company generates from the funds invested in it.
- EVA is calculated by subtracting the company’s cost of capital from its operating profit, adjusted for taxes on a cash basis.
- The formula for calculating EVA includes three key components: NOPAT, invested capital, and WACC.
- NOPAT represents the net operating profit after taxes, which can be calculated manually or obtained from a company’s financial statements.
- Invested capital refers to the amount of money used to fund a company or a specific project, and it includes debt, capital leases, and shareholders’ equity.
- WACC is the weighted average cost of capital, which represents the average rate of return a company expects to pay its investors.
- The formula for invested capital in EVA is usually total assets minus current liabilities.
- EVA is particularly useful for asset-rich companies that are stable or mature, as it relies heavily on the amount of invested capital.
- Companies with intangible assets, such as technology businesses, may not be good candidates for an EVA evaluation.
Calculating EVA
The formula for calculating EVA includes three key components: NOPAT, invested capital, and WACC.
NOPAT: Net operating profit after taxes, which can be calculated manually or obtained from a company’s financial statements.
Invested Capital: The amount of money used to fund a company or a specific project, and it includes debt, capital leases, and shareholders’ equity.
WACC: Weighted average cost of capital, which represents the average rate of return a company expects to pay its investors.
The formula for EVA is as follows:
EVA = NOPAT – (WACC x Invested Capital)
Advantages and Disadvantages of EVA
EVA has several advantages as a performance indicator:
- It shows how and where a company created wealth, through the inclusion of balance sheet items.
- It forces managers to be aware of assets and expenses when making managerial decisions.
However, EVA also has some disadvantages:
- It relies heavily on the amount of invested capital and is best used for asset-rich companies that are stable or mature.
- Companies with intangible assets, such as technology businesses, may not be good candidates for an EVA evaluation.
Conclusion
EVA is a useful measure of a company’s financial performance that can be used to assess the value a company generates from the funds invested in it. However, it is important to consider the advantages and disadvantages of EVA before using it to evaluate a company’s performance.
References
- Economic Value Added (EVA): Definition and Formula (https://www.investopedia.com/terms/e/eva.asp)
- Economic Value Added (EVA): Explanation and Example (https://www.investopedia.com/articles/fundamental/03/031203.asp)
- Economic Value Added: Basics | SendPulse (https://sendpulse.com/support/glossary/economic-value-added)
FAQs
What is the formula for calculating EVA?
EVA = NOPAT – (WACC x Invested Capital)
What is NOPAT?
NOPAT stands for Net Operating Profit After Taxes. It is calculated by taking a company’s operating profit and subtracting taxes.
What is Invested Capital?
Invested Capital refers to the total amount of money used to fund a company’s operations and assets. It includes debt, equity, and any other long-term investments.
What is WACC?
WACC stands for Weighted Average Cost of Capital. It represents the average cost of capital that a company pays to its investors.
How do I calculate NOPAT?
NOPAT can be calculated using the following formula:
NOPAT = Operating Profit + Depreciation & Amortization – Taxes
How do I calculate Invested Capital?
Invested Capital can be calculated using the following formula:
Invested Capital = Total Assets – Current Liabilities
How do I calculate WACC?
WACC can be calculated using the following formula:
WACC = (Cost of Debt x Debt % of Capital) + (Cost of Equity x Equity % of Capital)
What are some of the advantages and disadvantages of using EVA?
Advantages:
- It considers the cost of capital.
- It aligns the interests of managers and shareholders.
Disadvantages:
- It can be complex and time-consuming to calculate.
- It may not be suitable for companies with intangible assets.