Economic Value Added in corporate finance, Economic Value Added or EVA, a registered trademark of Stern Stewart & Co.

, is an estimate of a firm's economic profit being the value created in excess of the required return of the company's investors (being shareholders and debt holders). Quite simply, EVA is the profit earned by the firm less the cost of financing the firm's capital. The idea is that value is created when the return on the firm's economic capital employed is greater than the cost of that capital; see Corporate finance: working capital management. This amount can be determined by making adjustments to GAAP accounting. There are potentially over 160 adjustments that could be made but in practice only five or seven key ones are made, depending on the company and the industry it competes in.Contents [hide] 1 Calculating EVA 2 Comparison with other approaches 3 Relationship to market value added 4 See also 5 References 6 External links Calculating EVA EVA is net operating profit after taxes (or NOPAT) less a capital charge, the latter being the product of the cost of capital and the economic capital. The basic formula is:

where:

, is the Return on Invested Capital (ROIC); C is the weighted average cost of capital (WACC); K is the economic capital employed; NOPAT is the net operating profit after tax, with adjustments and translations, generally for the amortization of goodwill, the capitalization of brand advertising and others non-cash items. EVA Calculation: EVA = net operating profit after taxes a capital charge [the residual income method]

therefore EVA = NOPAT (c capital), or alternatively EVA = (r x capital) (c capital) so that EVA = (r-c) capital [the spread method, or excess return method] where: r = rate of return, and c = cost of capital, or the Weighted Average Cost of Capital (WACC). NOPAT is profits derived from a companys operations after cash taxes but before financing costs and non-cash bookkeeping entries. It is the total pool of profits available to provide a cash return to those who provide capital to the firm. Capital is the amount of cash invested in the business, net of depreciation. It can be calculated as the sum of interest-bearing debt and equity or as the sum of net assets less non-interest-bearing current liabilities (NIBCLs). The capital charge is the cash flow required to compensate investors for the riskiness of the business given the amount of economic capital invested. The cost of capital is the minimum rate of return on capital required to compensate investors (debt and equity) for bearing risk, their opportunity cost. Another perspective on EVA can be gained by looking at a firms return on net assets (RONA). RONA is a ratio that is calculated by dividing a firms NOPAT by the amount of capital it employs (RONA = NOPAT/Capital) after making the necessary adjustments of the data reported by a conventional financial accounting system. EVA = (RONA required minimum return) net investments If RONA is above the threshold rate, EVA is positive. Relationship to market value added Relation Ship The firm's market value added, or MVA, is the discounted sum (present value) of all future expected economic value added:

Note that MVA = PV of EVA.

More enlightening is that since MVA = NPV of Free cash flow (FCF) it follows therefore that the NPV of FCF = PV of EVA; since after all, EVA is simply the re-arrangement of the FCF formula. Market value added Market Value Added (MVA) is the difference between the current market value of a firm and the capital contributed by investors. If MVA is positive, the firm has added value. If it is negative, the firm has destroyed value. The amount of value added needs to be greater than the firm's investors could have achieved investing in the market portfolio, adjusted for the leverage (beta coefficient) of the firm relative to the market. The formula for MVA is:

where: MVA is market value added V is the market value of the firm, including the value of the firm's equity and debt K is the capital invested in the firm MVA is the present value of a series of EVA values. MVA is economically equivalent to the traditional NPV measure of worth for evaluating an after-tax cash flow profile of a project if the cost of capital is used for discounting. Enterprise Market Value: Enterprise value (EV), Total enterprise value (TEV), or Firm value (FV) is an economic measure reflecting the market value of a whole business. It is a sum of claims of all the security-holders: debtholders, preferred shareholders, minority shareholders, common equity holders, and others. Enterprise value is one of the fundamental metrics used in business valuation, financial modeling, accounting, portfolio analysis, etc. EV is more comprehensive than market capitalization (market cap), which only includes common equity.Contents [hide] 1 EV equation 2 Comments on basic EV equation 3 Intuitive Understanding of Enterprise Value

EV equation Enterprise value = common equity at market value + debt at market value + minority interest at market value, if any - associate company at market value, if any + preferred equity at market value - cash and cash-equivalents. Comments on basic EV equation All the components are taken at marketnot bookvalues, reflecting an opportunistic nature of the EV metric. Some proponents argue that debt should be accounted for at book value. This is particularly relevant in liquidation analysis, since using absolute priority in a bankruptcy all securities senior to the equity have par claims. Generally, also, debt is less liquid than equity so that the "market price" may be significantly different from the price at which an entire debt issue could be purchased in the market. In valuing equities, this approach is more conservative. Cash is subtracted because when it is paid out as a dividend after purchase, it reduces the net cost to a potential purchaser. Therefore, the business was only worth the reduced amount to start with. The same effect is accomplished when the cash is used to pay down debt. Value of minority interest is added because it reflects the claim on assets consolidated into the firm in question. Value of associate companies is subtracted because it reflects the claim on assets consolidated into other firms. EV should also include such special components as unfunded pension liabilities, employee stock option, environmental provisions, abandonment provisions, and so on, for they also reflect claims on the company's assets. EV can be negative in certain casesfor example, when there is more cash in the company than the value of the other components of EV. Intuitive Understanding of Enterprise Value A simplified way to understand the EV concept is to envision purchasing an entire business. If you settle with all the security holders, you buy EV.

Usage Because EV is a capital structure-neutral metric, it is useful when comparing companies with diverse capital structures. Price/earnings ratios, for example, will be significantly more volatile in companies that are highly leveraged. Stock market investors use EV/EBITDA to compare returns between equivalent companies on a riskadjusted basis. They can then superimpose their own choice of debt levels. In practice, equity investors may have difficulty accurately assessing EV if they do not have access to the market quotations of the company debt. It is not sufficient to substitute the book value of the debt because a) the market interest rates may have changed, and b) the market's perception of the risk of the loan may have changed since the debt was issued. Remember, the point of EV is to neutralize the different risks, and costs of different capital structures. Buyers of controlling interests in a business use EV to compare returns between businesses, as above. They also use the EV valuation (or a debt free cash free valuation) to determine how much to pay for the whole entity (not just the equity). They may want to change the capital structure once in control.