Economic Value Added
In finance, economic value added (EVA) measures the net value added by a company during a period. It equals net operating profit after tax minus average cost of capital employed.
It is a concept similar to net present value. While net present value calculates total value added over the life of a project in present value terms, the economic value added finds net value added in a single period.
If economic value added (EVA) for a period is positive, it means the management has increased the company's total worth. On the other hand, if the economic value added is negative it means that the cost of capital employed is greater than the profit generated by the company and this means a decline in the company's value over the period.
|Economic Value Added (EVA) = Net Operating Profit after Taxes − WACC × Capital Employed|
Stark Industries' earnings before interest and taxes for the financial year 2011 amounted to $5,130 million. Applicable tax rate is 35%. 60% of the company's assets are financed by debt which has an after tax cost of 3.8%, while 40% is financed by equity with a cost of 9.8%. Stark Industries average total capital employed over the period amounted to $50,420 million. Find Stark Industries' economic value added.
Economic Value Added = NOPAT − WACC × Capital Employed
NOPAT = EBIT × (1 − Tax Rate) = $5,130 million × (1 − 35%) = $3,334 million
WACC = 0.6 × 3.8% + 0.4 × 9.8% = 6.2%
Economic Value Added = $3,334 million − 6.2% × $50,420 = $208 million
This tells us that over the financial year 2011, Stark Industries added a total of $208 million to its value.
Written by Obaidullah Jan, ACA, CFA