What to Do
At its most basic, EVA is a straightforward calculation in which the cost of capital used to invest in a business or project is subtracted from its net operating profit. The formula is:
Example:
Suppose a business wants to develop a new operation that costs $12 million in capital over the next five years. The expected return is $3.75 million a year ($18.75 million in five years). EVA is calculated as follows:
Another method uses a more complex formula to measure difference in value:
What You Need to Know
- EVA expresses value in dollars, rather than as a percentage.
- For investors, EVA could be regarded as the most accurate definition of profit. For example, shareholders only gain when their allocation of after-tax profit is greater than the expected return on the original capital invested.
- EVA can be used to evaluate individual units as well as whole businesses. It enables companies to identify how different departments or operations perform in terms of wealth creation, and helps them make best use of their assets to generate income. It’s also useful for assessing the potential of new developments and opportunities.
Where to Learn More
Web Site:
Stern Stewart & Co.: www.sternstewart.com
