Economic Value Added (EVA)

Definition

Economic Value Added (EVA) is a financial performance metric that calculates the economic profit generated by a company in a given period. It is determined by subtracting the opportunity cost of capital from the firm’s net operating profit after taxes (NOPAT). EVA serves as an indicator of how efficiently a company is utilizing its investments and resources to create shareholder value.

Phonetic

Economic Value Added (EVA) in phonetics is: ih-kah-nom-ik val-yoo ad-ed

Key Takeaways

1. Economic Value Added (EVA) is a financial performance metric that calculates the economic profit (net operating profit minus cost of capital) generated by a company’s investments, highlighting the effectiveness of its capital allocation decisions.
2. EVA is considered a better measure of shareholder value and corporate performance than traditional metrics like net income or earnings per share (EPS), since it goes beyond these figures to factor in the cost of capital invested in the business, thus providing a more comprehensive picture.
3. Companies can use EVA to identify underperforming assets and prioritize resource allocation, ensuring that investments are directed towards projects that generate the highest returns, ultimately improving financial performance and shareholder value.

Importance

Economic Value Added (EVA) is an important business and finance metric as it allows companies to assess their true economic performance by measuring the profit generated above and beyond the cost of capital. By taking into account both the operating profits and the cost of financing a business, EVA provides a clear view of whether a company is creating or destroying shareholder value. This valuable insight can guide business leaders in making better strategic decisions, prioritizing investments, and promoting efficient resource allocation. Ultimately, EVA fosters value creation, driving corporate growth and enhancing long-term shareholder wealth.

Explanation

Economic Value Added (EVA) serves as an essential financial performance metric aimed at evaluating a company’s profitability and economic success. Essentially, it provides a quantifiable measure of the wealth generated by a business venture, over and above the cost of capital invested, thereby assisting stakeholders in determining the firm’s effectiveness in generating shareholder value. Unlike traditional performance indicators, EVA takes into account both the operating profits and the capital costs, thereby reflecting a more comprehensive understanding of a company’s performance. In essence, the purpose of EVA is to encourage decision-makers to direct their focus on long-term value creation for shareholders instead of merely aiming for short-term profits. Companies utilize EVA to analyze various aspects of their operations and implement strategic initiatives designed to enhance shareholder value. By assessing the EVA generated by different business segments or projects, managers can identify value-creating areas that deserve more investment and areas where resources should be reallocated or minimized. Furthermore, EVA can serve as a critical component in performance-related compensation, aligning the interests of management and shareholders by rewarding executives based on actual shareholder value creation. Overall, EVA provides an invaluable tool for businesses to scrutinize their financial performance, make informed decisions, and foster a corporate culture geared towards maximizing shareholder wealth.

Examples

Economic Value Added (EVA) is a financial metric that measures a company’s profitability by taking into account the cost of capital. It is calculated by subtracting the cost of capital from the company’s net operating profit after tax (NOPAT). Here are three real-world examples illustrating the concept of EVA: 1. Coca-Cola: Coca-Cola, a leading beverage company, has consistently shown a high EVA over the years, indicating a high rate of wealth generation for its shareholders. In 2020, the company reported a net operating income of $8.9 billion and a weighted average cost of capital (WACC) of 6.4%. By subtracting the cost of capital from the NOPAT, Coca-Cola’s EVA reflects the company’s ability to create value for its shareholders. 2. Apple Inc. Apple Inc., a technology giant, has long been known for delivering exceptional shareholder value through its robust profitability. For the year 2019, Apple’s NOPAT stood at $66.3 billion, while the company’s WACC was around 10.25%. By calculating the EVA, we find that Apple has been successful in creating significant economic value for its shareholders, which contributes to the company’s high market valuation. 3. Amazon.com Inc. Another example of a company with a high EVA is Amazon.com. In 2019, the e-commerce giant reported a NOPAT of $14.5 billion and a WACC of around 9%. Using the EVA formula, we can infer that Amazon has effectively generated economic value for its shareholders. This success can be attributed to its continuous expansion into new markets, efficient capital allocation, and innovation in technology and logistics.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Net Operating Profit After Tax (NOPAT)
• Weighted Average Cost of Capital (WACC)
• Capital Employed
• Market Value Added (MVA)
• Return on Invested Capital (ROIC)

Sources for More Information

• Investopedia
• Corporate Finance Institute
• Wikipedia
• Finance Strategists