What is EVA?

1. What is EVA? • Economic Value Added is the financial performance measure that comes closer than any other to capturing the true economic profit of an enterprise. • EVA also is the performance measure most directly linked to the creation of shareholder wealth over time. • EVA is net operating profit minus an appropriate charge for the opportunity cost of all capital invested in an enterprise. As such, EVA is an estimate of true "economic" profit, or the amount by which earnings exceed or fall short of the required minimum rate of return that shareholders and lenders could get by investing in other securities of comparable risk.

2. What is EVA? • EVA = Net Operating Profit After Tax – [Capital*Cost of Capital] • As Peter Drucker put the matter in a Harvard Business Review article, “Until a business returns a profit that is greater than its cost of capital, it operates at a loss. Never mind that it pays taxes as if it had a genuine profit. The enterprise still returns less to the economy than it devours in resources…Until then it does not create wealth; it destroys it”. • From http://www.sternstewart.com/evaabout/whatis.shtml

3. EVA Example • Strategy Inc is company with 1 million equity and 1 million in debit • Lets say its Sales = 10,000,000 Expenses = 9,850,000 EBIT = 150,000 Interest = 100,000 (10% of 1 million) Profit = 50,000 We pay Tax & Managerial Bonus on this amount But is this true profit?

4. EVA Example • Strategy Inc is company with 1 million equity and 1 million in debit • Lets say its Sales = 10,000,000 Expenses = 9,850,000 EBIT = 150,000 Interest = 100,000 (10% of 1 million) Profit = 50,000 We pay tax on this amount – But is this true profit? What about cost of equity? 1 million @ 10 % = 100000 EVA = 50,000 – 100000 = -50,000