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Economic Value Added(EVA) Approach - Features, Advantages.

In present scenario the Economic Value Added(EVA) is becoming popular. 

Economic Value Added definition:
EVA (Economic Value Added) is basically the excess amount left on after making a proper charge for the capital invested in the business.  It different ways economic value added calculation can be done. They are, 

Different types of Economic Value Added (EVA) Formula are: 

2. EVA = CAPITAL (r-c*) 
3.EVA = [PAT + INT (1-t)] - C* CAPITAL

NOPAT = Net Operating Profit After Tax.
C*= Cost of Capital
CAPITAL= Economic book value of the capital invested in the firm.
r= return on capital (NOPAT/CAPITAL)
PAT=Profit After Tax.
INT+ interest expense of the firm.
t=Marginal tax rate of the firm.
Kc= Cost of equity.
EQUITY= Equity utilized in the firm.

Important Features and Advantages of EVA Approach:

  • It acts as performance measure which is linked to share holder value creation in all directions.
  • It is useful in providing business knowledge to everyone.
  • It is an efficient method for communicating to investors.
  • It transforms the accounting information into economic quality which can be easily understood by non financial managers.
  • It is useful in evaluating Net Present Value(NPV) of projects in capital budgeting which is contradictory to IRR.
  • Instead of writing the value of firm in terms of discounted cash flow, it can be expressed in terms of EVA of projects.

FYI: This approach was developed by Stern Stewart & Co, and later with different names like Peter Drucker referred it as "measure of total factor productivity",  feature magazine as "today's hottest financial idea and getting hotter"


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