Economic Value Added Definition with Example
Economic Value Added Definition – “Net income minus a charge for the cost of a company’s capital”.
In simple terms EVA is the difference between the cost of capital and the rate of return. It is the value of the investment made by a company. If it is negative, that means the investment value is decreasing day by day. Sometimes, it is also known as economic profit. This device is coined by Stern Stewart and Co. This concept is used to measure the value of the money from the funds invested. At the same time, if it is positive, it means company is earning funds from the investment.
Economic Value Added Formula
EVA = Net operating profit after taxes – Capital Invested × Weighted Average Cost of Capital (WACC)
Net operating profit after taxes generally appears on the Balance Sheet of the company. On the other hand capital investment made is the amount utilize to fund a specific project. WACC is the average rate of return that a company pays to its investors.
Economic Value Added Example
To understand the Economic Value Added Definition, let’s discuss an example.
Net operating profit after tax – 23,00,000
Capital invested – 13,00,000
WACC – 5% or 0.50
EVA = 23,00,000 – (13,00,000 × 0.50)
Related Financial Terms of Economic Value Added
- Shareholders Equity Meaning – Definition, Formula, Importance
- Balance Sheet Definition | What is Balance Sheet?
Importance of EVA for Business
This concept of finance measures the company and management performance. This follows the wealth maximization concept. According to this concept, a company is profitable when it provides maximum return to its shareholders. It acts as a performance indicator. It also helps managers in making right decisions. However, for companies who are in intangible business, this concept is quite vague.