Economic Value Added (EVA
) is the financial profit performance measure most directlylinked to the creation of shareholder wealth over time.EVA is net operating profit after tax, or NOPAT, minus an appropriate charge for theopportunity cost of all capital invested, including equity plus debt. As such, EVA is anestimate of true economic profit, or the amount by which earnings exceed or fall short of therequired minimum rate of return that shareholders and lenders could get by investing inother securities of comparable risk. EVA also eliminates a group of 15 key accountingdistortions, which tend to reduce the link between profit and share value.
EVA is sales less operating costs (including taxes) less all financing costs. Put another way,EVA is net operating profit after tax (NOPAT) less the cost of all capital, equity as well asdebt.For example, consider a company that earns NOPAT of $100 and ties up $800 in capital fromdebt and equity sources to support its business assets. Assume further that the firm's overallcost of capital is 10%, a rate that blends the after-tax cost of debt and equity at theproportions management would intend to use as a target. In this case, the firm must setaside $80 ($800 x 10%) to "rent" its capital from the market, and its EVA is $20, the profitresidual.
EVA = NOPAT - (Cost of Capital x Total Capital)$20 = $100 - ( 10% x $800 )
EVA may also be expressed as the monetary spread between the return on capital and thecost of capital:
EVA = (ROTC - Cost of Capital) x Total Capital$20 = (12.5% - 10% ) x $800
The capital charge is the key to understanding the significance of EVA to investors. Itrepresents the amount a firm must earn to cover its interest expense-after-tax-and leave a