What Is Economic Value Added? Essay
Economic Value Added (EVA) is a method of analysis which is used to accurately measure the current financial performance of a firm. This analysis is based on the premise that all things have a cost in capital (Dierks & Patel, 1997), and that if the given firm within all its divisions and project is earning more than its cost in capital; then that firm is creating true economic value for investors.
How to conduct Economic Value Added Analysis To conduct the analysis and determine a firm’s EVA, let us first consider that the difference between a firm’s current market value and its total assets is referred to as the firm’s Market Value Added (MVA). This is what firm mangers desire to increase. They do so by ensuring that the capital being invested is earning a greater rate of return than the cost of capital lending; as demonstrated by a positive Net Present Value (NPV). To calculate the EVA a manger or investor first subtracts the firm’s operating expenses from its net sales to determine the firm’s operating profits. Next its taxes are subtracted from its operating profits to determine the firm’s net operating profits. From there, the firm’s capital charges are then subtracted from the net operating profits to discover the Economic Value Added (EVA); for the point in time under consideration.
Why use Economic Value Added Analysis A firm’s managers must ensure that the capital being provided by investors is being utilized judiciously to…