Q.1. Define EVA & ROI? What are the differences between EVA and ROI?

ECONOMIC VALUE ADDED (EVA)

Economic Value Added (EVA) term was formed & Introduce by a New York Consulting firm, Stern
Steward & Co in 1982 to boost the value-maximizing behavior in corporate managers. Economic
Value Added (EVA) term has been used in the book named The Quest for Value which was
published in 1991.
Basically EVA is a value-based measure that was designed to evaluate the business strategies, capital
projects and to increase the long-term shareholders wealth.
Economic value added (EVA) is a measure of a company's financial performance based on the residual
wealth calculated by deducting its cost of capital from its operating profit, adjusted for taxes on a cash
basis. EVA can also be referred to as economic profit, and it attempts to capture the true economic
profit of a company.
The ECONOMIC VALUE ADDED (EVA) formula is:
EVA=Net profit- Capital charge
Where,
Capital charge = Cost of capital * Capital employed

Return on investment (ROI)

Return on investment (ROI) measures the gain or loss generated on an investment relative to the
amount of money invested. ROI is usually expressed as a percentage and is typically used for personal
financial decisions, to compare a company's profitability or to compare the efficiency of different
investments.
The return on investment formula is:
ROI = (Net Profit / Cost of Investment) x 100
For example, an investor buys $1,000 worth of stocks and sells the shares two years later for $1,200.
The net profit from the investment would be $200 and the ROI would be calculated as follows:
ROI = (200 / 1,000) x 100 = 20%

Difference between ROI and EVA

Subject EVA ROI
Meaning EVA is the residual profit after ROI is the comparison of the
taking into account the capital income generated with the
charge. assets employed.
Measure EVA is an absolute measure. ROI is a relative measure.
Measuring Tool EVA is performance measuring ROI is an accounting
tool. measuring tool.
Thought EVA is an advanced thought. ROI is in accordance with
tradition.
Way to express result EVA is in currency. ROI is described in term of
percentage.
Superiority Conceptually EVA is superior Conceptually EVA is superior
than ROI than ROI
Cost of capital
Profit used for Calculation Profit before interest and tax is Profit after interest and tax is
used. used.
Formula for Calculation EVA = Net Operating Profit After ROI = Earnings Before Interest
Tax (Operating Assets* Cost of and Tax (EBIT) / Capital
Capital) Employed

Q.3. How do you Calculate Economic Value Added? Give some Examples.

Net Sales
-
Operating Expenses
___________________________
Operating Profit (EBIT)

- Taxes
___________________________
Net Operating Profit After Tax (NOPAT)

- Capital Costs (Total Capital x Cost of Capital)

___________________________

Economic Value Added

4 Steps to Calculate Economic Value Added

i) Calculate Net Operating Profit after Taxes

Gross Sales = $1,000,000

Operating Expenses = $350,000

Depreciation = $100,000

Taxes = $150,000

Net Operating Income = $1m - $350k - $100k - $150k = $400,000

ii) Determine total Capital deployed in the business

Total Capital = Net Working Capital + Net Fixed Assets

Total Capital = $300,000 + $1.2m

Total Capital = $1,500,000

iii) Calculate Weighted Average Cost of Capital

Assume WACC = 12%

iv) Calculate Capital cost to NOPAT & Economic Value Added

Capital Costs = Total Capital x Cost of Capital

Capital Costs = $1,500,000 x 0.12

Capital Costs = $180,000

Economic Value Added = Net Operating Income - Capital Costs

Economic Value Added = $400,000 - $180,000

Economic Value Added = $220,000

Matter