What Is Economic Value Added (EVA)?
Economic Value Added (EVA) is a financial performance measure used to determine whether a company is generating value beyond the cost of the capital it uses. Unlike traditional accounting profit, EVA considers the opportunity cost of capital, making it a more accurate indicator of real economic profit. The concept became widely known after being popularized by the consulting firm Stern Stewart & Co.
EVA helps investors, managers, and analysts evaluate whether a company’s investments truly create wealth for shareholders.
EVA Formula
The basic Economic Value Added formula is:
EVA = Net Operating Profit After Taxes (NOPAT) – (Invested Capital × Cost of Capital)
Where:
- NOPAT represents the company’s operating profit after taxes but before financing costs.
- Invested Capital refers to the total funds used to operate the business, including debt and equity.
- Cost of Capital reflects the required return expected by investors.
If EVA is positive, the company is creating value. If it is negative, the company is destroying shareholder value.
Example of Economic Value Added
Consider a company that reports the following:
- Net Operating Profit After Taxes (NOPAT): $500,000
- Invested Capital: $2,000,000
- Cost of Capital: 10%
First calculate the capital charge:
Capital Charge = $2,000,000 × 10% = $200,000
Now calculate EVA:
EVA = $500,000 – $200,000 = $300,000
In this example, the company generated $300,000 in economic profit, meaning it produced returns above the required return expected by investors.
Why EVA Is Important in Corporate Finance
Economic Value Added is widely used in corporate finance, investment analysis, and performance management because it shows whether management is truly creating shareholder wealth. By focusing on value creation rather than accounting profit, EVA provides a clearer picture of a company’s financial performance and long-term sustainability.