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Economic Value Added:
Means to measure and estimate the actual value of the company in light of the investment return required by an investor in the company and is computed by calculating the net profit resulting from operations after tax is deducted from the invested capital and strikes at the weighted average cost of capital.
is a new measure of performance that is purported to better align managers’ incentives to that of the shareholders. Accordingly, firms that experience higher agency conflicts should be more inclined to use this performance evaluation system. Additionally, the organizational strategy of the firm should influence the likelihood of employing EVA. Prospector firms are defined as firms that apply a differentiation strategy while defender firms focus on being cost-leaders. Firms identified as prospectors should be less likely to use EVA. One hundred and fifteen firms were identified as being adopters of EVA. Logistic regression was performed to contrast these firms to a control group of1271 non-adopters. The results indicate that firms using EVA exhibit a higher percentage of institutional ownership and a lower percentage of insider ownership than non-adopters. Prospector firms as defined by a higher ratio of research and development to sales tend to use EVA less than defender firms. Accounting adjustments are a focal point of the EVA formulation and the results presented in this study suggest that providing appropriate incentives may be more complex than the developers of EVA imply.
The Firm estimates an economic profit which it earns from its normal operations, if exceeds the required return of the company's investors (shareholders + debts) is called economic value added.
in one sentence
The profit earned by the firm less the cost of financing the firm's capital.
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Management viewpoint
- EVA is a measure to guage return on capital employed on Net Operating profit after taxes. It helps in distribution of weighted average market return among various key stakeholders. Stakeholders include institutional investors, Banks, lending firms, equity share holders and short term creditors). In other words it evaluates the firms operating performance and best use of its finances to give effective & required rate of return, on different forms of its investments.
- It also helpful to asses future profitability based on average current market risk over return (r/r) trends.
- EVA (Economic Value Added) is more refined name of ROI (Return on Investments) or ROCE (Return on Capital employed). Most of the companies and now also rating agencies use this key performance indicator (KPI) to guage economic viability of the firm to service its debts and equity finances on its residual income (RI), or on its Net Operating Profit after taxes (NOPAT).
Formula adaption & explanation
EVA = Net Operating Profit after tax - {(WACC weighted average cost of capital {rate}) x (Assets-current Liabilities)}
Explanation
EVA substitutes the following numbers in the RI calculations: (1) income equal to after-tax operating income, (2) required rate of return equal to the (after-tax) weighted-average cost of capital, and (3) investment equal to total assets minus current liabilities. [Hongren] - (Cost Accounting - Managerial Emphasis14ed.)
The Economic Value Added (EVA) is a measure of surplus value created on an investment. In other words it is the profit earned by the firm less the cost of financing the firm’s capital.
EVA = (Return on Capital - Cost of Capital) (Capital Invested in Project)
EVA = net operating profit after taxes – a capital charge - [the residual income method]
In corporate finance, Economic Value Added (EVA), is an estimate of a firm's economic profit – being the value created in excess of the required return of the company's investors (being shareholders and debt holders). Quite simply, EVA is the profit earned by the firm less the cost of financing the firm's capital. The idea is that value is created when the return on the firm's economic capital employed is greater than the cost of that capital. This amount can be determined by making adjustments to GAAP accounting. There are potentially over160 adjustments that could be made but in practice only five or seven key ones are made, depending on the company and the industry it competes in.
