ECONOMIC VALUE ADDED (EVA)
Economic Value Added (EVA) or Economic Profit is after-tax net operating profit (NOPAT) minus a capital charge. This measure is based on the Residual Income technique that serves as an indicator of the real profitability of business. The real profitability occurs when additional wealth is created for share shareholders and the business creates returns above their cost of capital. Thus, the Economic Value Added (EVA) is a value based performance measure that gives importance on value creation by the management for the owners.
EVA can be expressed as follows:
EVA = NOPAT – (WACC × capital invested)
[WACC × capital invested is also known as finance charge]
Where NOPAT = Net Operating Profits after Tax
WACC = Weighted Average Cost of Capital
Capital invested = Equity + long-term debt at the beginning of the period
Illustration:
| 2016 | 2017 | 2018 | |
| Capital invested (beginning of the year) | Rs.90000 | Rs.85000 | Rs.95000 |
| WACC | 8.22% | 8.28% | 8.38% |
| Financial charge (WACC × capital invested) | Rs.7398 | Rs.7038 | 7961 |
| NOPAT | Rs.8225 | Rs.7958 | 7721 |
| EVA
(NOPAT-in.Charges)
|
827 |
920 |
-240 |
The positive numbers during 2016 and 2017 projects Economic Value Added for a Company. A negative number during 2018 indicates that the company did not make enough profit to cover the cost of doing business.
