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EVA is calculated as net operating profit after tax minus a charge for the opportunity cost of the capital invested.
EVA = Net Operating - ( Capital X Profit After Tax Cost of Capital)
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.
The capital charge is the most distinctive and important aspect of EVA Unlike accounting profit such as EBIT, Net Income and EPS, EVA is economic and based on idea that a business must cover both the operating and capital cost.
Under conventional accounting, most companies appear profitable but many in fact are not.
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 resourcesUntil then it does not create wealth; it destroys it."
EVA corrects this error by explicitly recognizing that when managers employ capital they must pay for it, just as if it were a wage. By taking all capital costs into account, including the cost of equity, EVA shows the dollar amount of wealth a business has created or destroyed in each reporting period.
In other words, EVA is profit the way shareholders define it. If the shareholders expect, say, a 10% return on their investment, they "make money" only to the extent that their share of after-tax operating profits exceeds 10% of equity capital.
Everything before that is just building up to the minimum acceptable compensation for investing in a risky enterprise.
Advantage of EVA
Setting organizational goal Performance measurement Bonus Determination Corporate Valuation
Limitation of EVA
It neither forecast future cash flows nor measure present value. It depends on current level of earning of company. It reward managers who take on projects with quick paybacks and penalize those who invest in projects with long gestation period. Such as pharmaceutical research program, hydro power project etc.
MVA is equal to present value of all future expected EVAs. MVA doesn't take into account of the opportunity cost of invested capital. MVA can not be used in SBU level and private held companies. Where as EVA can be calculated at SBU level.