Economic value added (EVA) measures a company's or project's financial success based on residual wealth. Also known as economic profit, it is calculated by subtracting the cost of capital from operating profits. EVA determines the value that a company generates from the capital it invests with the overall goal of improving the returns generated for 澳洲幸运5官方开奖结果体彩网:shareholders.

There are two major ways a company can improve its 澳洲幸运5官方开奖结果体彩网:economic value added: increase revenues or decrease capital costs. Revenue can be increased by raising prices or selling additional goods and services. Capital costs can be minimized in several ways, including increasing economies of scale. It is also possible for a firm to 𝔍offset capital costs by choosing investments that earn more than their associated capital charges.

What Is Economic Value Added (EVA)?

EVA was developed by Stern Value Management to measure the difference between the 澳洲幸运5官方开奖结果体彩网:cost of capital and the 澳洲幸运5官方开奖结果体彩网:rate of return, creating a path for companies to determine whether capital invested into the company will be a drag on assets or help it 澳洲幸运5官方开奖结果体彩网:in terms🔜 of successful financial perfor🌳mance.

When the EVA is positive, it indicates that a company is generating economic profit. A negative EVA shows that a company is not generating wealth for shareholders from its capital commitments.

EVA is sometimes also referred to as 澳洲幸运5官方开奖结果体彩网:shareholder value added (SVA), although some companies might make different adjustments in their NOPAT and cost of capital calculations. These are not the same as 澳洲幸运5官方开奖结果体彩网:cash value added (CVA), which is a metric used by value investors to see how well a company can generate 澳洲幸运5官方开奖结果体彩网:cash flow.

Formula for Economic Value Added (EVA)

The formula for EVA is as follows:

$\begin{aligned}&\text{Economic Value Added}\\&\quad=\text{Net Operating Profits After Tax}\\&\qquad-(\text{Weighted Average Cost of}\\&\qquad\qquad\text{Capital}\times\text{Capital Invested})\\&\textbf{where:}\\&\text{Capital Invested}=\text{Equity}\!+\!\text{Long Term}\\&\text{Debt at the Start of the Period}\end{aligned}$​Economic Value Added=Net Operatin꧒g Profits&꧅nbsp;After Tax−(Weighted Average Cost ofCapital×Capital Invested)where:Capital Invested=Equity+Long TermDebt at the&nbs📖p;Start of 🐬;the Period​

How to Increase Economic Value Added (EVA)

In the EVA formula, a firm's revenue is expressed as being equal to net operating profits after tax (NOPAT). Capital costs are traditionally estimated using a weighted average cost of capital (WACC). EVA is the result of subtracting all net capital charges from NOPAT. Below are two ways to increase EVA.

Increasing Revenue

Traditional methods of increasing revenue include increasing prices and increasing the number of goods sold. Increasing prices is straightforward, a company charges more for a product or service than it did before. If costs remain the same this will then increase the 澳洲幸运5官方开奖结果体彩网:profit margin. The only downside to this tactic is that certain consumers may not be willing to pay more for the same product, which could lead to a decrease in demand and, therefore, a decrease in revenue.

Selling more goods would increase revenues, as long as the cost of producing more goods to meet the increased demand doesn't outweigh the benefit. Meaning, if a company wants to improve its EVA by adding to its revenues, it must ensure the 澳洲幸运5官方开奖结果体彩网:marginal revenue gain is larger than the accompanying marginal costs, including taxes. This makes sense; you would not spend $150 to earn an addiꦿtional $100 in revenue.

For example, if you need to create a new factory to meet the additional demand🌸 for𒅌 goods, you would need to ensure that the return on investment of the factory is greater than the WACC.

Since r💙evenue generation is usually uncertain, it﷽ is often easier for a company to reduce its net capital costs.

Decreasing Capital Costs

Net capital costs can be lowered by reducing operating expenses, increasing marginal productivity, or liquidating capital that does not cover the cost of🌃 capital for the purpose that it is associated with.

To reduce operating expenses, a company might renegotiate with its creditor to acquire a lower interest rate on debt, it may negotiate better terms with its 澳洲幸运5官方开奖结果体彩网:suppliers, and it may be ꧟able to get better terms on rent for its office or factory space.

A company may also improve its marginal productivity by reaching 澳洲幸运5官方开奖结果体彩网:economies of scale. Here, a company would be able to figure out a way to produce the same amount of goods at a lower cost, or conversely, produce more goods without a significa෴nt increase in costs. This can be achieved by arriving at improved means of efficiency, such as a better production plan or new technology.

The Bottom Line

Economic value added is a way for companies to determine if the capital invested into the company will add value to shareholders. A positive EVA indicates that the c♓apital invested is generating returns above the minimum required return and a negative EVA indicates the opposite.

T𝓰o increase E♕VA, a company can increase revenues by increasing the price or the number of goods sold, as long as the marginal cost to produce more units is not above the marginal return. Companies can also decrease their capital costs by improving operational efficiency and reaching economies of scale.