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Unit 4: Economic Value Added (EVA)

By reducing the cost of capital, which means employing more debt, as debt is cheaper Notes
than equity or preference capital.
The EVA concept is very closely related to the NPV concept. The present value of an
investment annual EVA stream is the same as its NPV. NPV analysis is a one-time measure
of the value added by an investment. EVA is a continuous annual value added measure.

Self Assessment

Fill in the blanks:

13. EVA ignores ……….. and it is biased against new assets.
14. EVA is just a refinement of …………….
15. …………..is defined as the difference between profit and the cost of capital.

4.6 Summary

Economic value added (EVA) is an important form of value addition.
EVA is ascertained as excess of return over cost of capital.
EVA measures whether operating profit is sufficient enough to cover cost of capital and
how much of EVA is generated to justify risk taken by the shareholders.
EVA can be improved by increasing returns, by reducing asset base, by reducing cost of
capital etc.

Participation of employees and managers in EVA is a modern concept of compensation
system for improving the corporate efficiency and results.

EVA forces managers to focus on value creating activities rather than wasting time and
energy on playing with the accounting principles.
The EVA based bonus system is based on performance of employees and managers.

EVA ignores inflation and it is biased against new assets. Whenever a new investment is
made, capital charge is on the full cost initially, so EVA figure is low.

4.7 Keywords

Economic Value Added (EVA): EVA is a management philosophy and performance metric that
elevates those goals from intuition to rigorous analysis and ensures that no investment escapes
scrutiny.
Return on Investment: It is the earning capability of the unit/company on the capital investment.

Total capital employed: The total capital employed is the sum of shareholders funds as well as
loan funds.

4.8 Review Questions

1. EVA holds a company accountable for the cost of capital it uses to expand and operate its
business and attempt to show whether a company is creating a real value for its
shareholders. Discuss.
2. What is Economic Value Added (EVA)? What does EVA show? When will EVA increase?

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