In Practice Economic Value Added EVA

Economic value added is a value enhancement concept that has caught the attention of both firms interested in increasing their value and portfolio managers, looking for good investments. EVA is a measure of dollar surplus value created by a firm or project and is measured by doing the following:

Economic Value Added (EVA) = (Return on Capital - Cost of Capital) (Capital Invested) The return on capital is measured using "adjusted" operating income, where the adjustments9 eliminate items that are unrelated to existing investments, and the capital investment is based upon the book value of capital, but is designed to measure the capital invested in existing assets. Firms that have positive EVA are firms that are creating surplus value, and firms with negative EVA are destroying value.

9 Stern Stewart, which is the primary proponent of the EVA approach, claims to make as many as 168 adjustments to operating income to arrive at the true return on capital.

While EVA is usually calculated using total capital, it can be easily modified to be an equity measure:

Equity EVA = (Return on Equity - Cost of Equity) (Equity Invested in Project or Firm) Again, a firm that earns a positive equity EVA is creating value for its stockholders while a firm with a negative equity EVA is destroying value for its stockholders.

The measures of excess returns that we computed in the tables in the last illustration can be easily modified to become measures of EVA:

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