## Tuesday, 22 January 2019

An Economic value added (EVA) is an internal management performance measure that compares net operating profit to total cost of capital.

Is the result of a reduction in the total capital costs against operating profit after tax. Cost of capital on its own in the form of cost of debt and the cost of equity.

### EVA formula

Economic value added is calculated by deducting capital cost from the company’s operating profit (adjusted for taxes on a cash basis).

The formula for EVA is:

(Net investment) x (Actual return on investment – Percentage cost of capital)
So, imagine a company has:
• Net Investment: \$2,000,000.
• Actual Return on Investment: 16%.
• Cost of Capital: 12%.
The calculation would be as follows:
(\$2,000,000 net investment) x (16% actual return on investment minus 12% cost of capital)
• which equals \$2,000,000 net investment x 4%.
Therefore Economic Value Added is \$80,000. It is generating a healthy economic value on the money invested in it. It more than covered its cost of capital.
Stern Steward & Co., based in Munich, Germany, is credited with devising economic value added (a trademarked concept).

Economic Value Added can be formulated as follows:

EVA = NOPAT-(Capital x c) or EVA = (r-c) x Capital

#### where:

• NOPAT Net Operating Profit is After Tax, i.e. net income (Net Income After Tax) plus interest after tax.
• c is the cost of capital is the cost of the loan interest rate and the cost of Equitas used to generate the NOPAT (Net Operating profit After Tax) and calculated the weighted average (Weighted Average Cost of Capital).
• R is a continuous level of capital (rate of return), the NOPAT divided by Capital.
• Capital is the amount of funds available for the company to finance its business.
As for the measures being undertaken in calculating EVA (Economic Value Added) in more detail as follows:
• Calculate the cost of debt and the cost of equity over
• Calculate the capital structure of the balance sheet
• Calculate NOPAT
• Calculate the rate of return (r)
• Calculate the cost of capital weighted average (C)
• Calculate The EVA (Economic Value Added)
EVA is similar to normal profit calculation but with two important differences, namely EVA consider the cost of capital and not at all deterred by the existence of a set of GAAP in the financial statements of the company.

Net profit reported in the income statement of the company only consider most of that looks at capital cost like interest-which ignore the cost on equity finance.

Financial accounting does not calculate the cost on finance received by shareholders because it is a lost opportunity cost which cannot be measured directly. But in fact it is not so.

#### Example

John is the M.D of an organization in Boston. In order to assess the organization’s value creation or destruction, John would like to calculate economic value added for 2019. The organization’s NOPAT is \$3,500,000, cost of capital is 5%, and the organization employed 1,000,000 in capital in 2019.

By plugging the values into the EVA calculation above, we can compute the value that John needs:

\$3,500,000 – ( 1,000,000 x 5% ) = \$3,450,000

John’s organization had a total added value amount of \$3,450,000 in 2019.

The cost of capital includes the value of all the funds required to finance the company, which can vary greatly according to how the company is financed. If the company is financed by equity, the cost of capital is the cost of equity; in the case of companies financed by debt, the cost of capital is the cost of that debt.

#### 1 comment:

1. Thank you so much for sharing this worth able content with us. The concept taken here will be useful for my future programs and i will surely implement them in my study. Keep blogging article like this.
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