ECONOMIC VALUE ADDED (EVA)

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Strategic Management:

Resource-Based Model

Economic Value Added

A Tool to Measure Efficiency With Which a Company Uses Its Resources

by Ten3 East-West

"Profits should be a reflection not of a corporate greed but a vote of confidence from society that what is offered by the firm is valued." - Konosuke Matsushita

Economic Value Added (EVA) vs. Earning per Share (EPS)

EPS is calculated by dividing the net profits (after interest, depreciation and taxation) by the number of equity shares issued by the company to find out the profits earned per share. This measure is flawed because it does not consider the equity cost of capital employed (i.e. it assumes that equity capital comes to the company for free). EPS can be improved without corresponding improvement in performance simply by issuing further equity at a premium. Naturally, when more funds are pumped into the company, the size of the business increases without necessary increasing the profitability.
EVA takes into consideration the total capital employed by the company - total shareholders' fund (equity and accumulated profits) and total debt - and finds out the difference between the earning and the cost of the capital employed.

Related Chapters of the Business e-Coach:

Resource-Based Model

Performance Measurement System

Economic Value Added (EVA) Defined

Economic Value Added (EVA), or economic rent, is a widely recognized tool that is used to measure the efficiency with which a company has used its resources. In other words, EVA is the difference between return achieved on resources invested and the cost of resources. Higher the EVA, better the level of resource unitization.

How EVA Is Calculated

EVA = Net Profit (after tax but before interest) less cost of capital employed (equity + debt).

Interest is not taken as an expense since this is part of cost of capital (interest on debt).

How EVA Affects a Company's Market Capitalization

Market Value Added (MVA) - which is the difference between the market value of the company and the total capital invested in the company - recognizes the EVA performance of companies. Positive MVA indicates creation of wealth and a positive EVA and vice versa.

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