economic value added


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Economic value added (EVA)

A method of performance evaluation that adjusts accounting performance for investors' required return on investment. Suppose a division produces a 12% return on capital invested. Given the risk of the division's business line, if investors would usually require 14% on capital invested for this level of risk, the division destroyed shareholder value by the EVA metric. This Stern-Stewart has a trade mark on this term.

Economic Value Added

A company's after-tax earnings less its opportunity cost. The economic value-added measure is a metric of how well it has performed over a given period of time compared to how it could have performed.

economic value added (EVA)

a measure of a firm's overall profit (loss) position when allowance is made for the OPPORTUNITY/ECONOMIC COSTS of the firm's capital (that is, the revenues the firm's assets could have earned in some alternative use). Whereas accounting PROFIT = SALES REVENUE less accounting COSTS (see PROFIT AND LOSS ACCOUNT), EVA = sales revenue less accounting cost less opportunity economic costs.

To illustrate: assume sales revenue is £1,000,000 and accounting cost is £900,000; on conventional criteria the firm thus makes an accounting profit of £100,000. However, when allowance is made for the opportunity cost of the firm's assets if liquidated and redeployed in an alternative use the picture changes. If the firm's assets could have earned, say, £200,000 in some alternative activity (e.g. even putting the money on interest-bearing deposit with a bank) then the positive accounting profit is turned into an economic loss of £100,000. Thus, shareholders' wealth has been ‘destroyed’ rather than ‘created’.

However, whilst producing accurate accounting cost and profit data can be difficult, obtaining reliable economic cost and profit data can be even more problematic. For example, a high proportion of the investment in the firm's current activity may represent a ‘sunk’ cost with little prospect of recovery if liquidated, while there is a difficulty in identifying which are likely to be viable alternative activities where the firm's new investment might yield higher profit returns than currently being achieved.

References in periodicals archive ?
Kim (2006) compared the relative and incremental information content of Economic Value Added and accounting ratios as predictors of market value.
The Relationship between Economic Value Added and Market Value Added: An empirical analysis in Indian Automobile Industry".
According to the aforementioned study, the main study objectives are reviewing and explaining the relationship between the cash conversion cycle and economic value added in Tehran Stock Exchange.
A positive relation of economic value added to the capital invested ranged in the above companies from 0.
Karam Pal and Ashok Kumar [3] )used Granger causality test to answer the question which parameter like Return on Capital Employed Net Operating profit after tax Earning per share Labour productivity Capital productivity Market Value Added Economic Value Added closely related with the market price of security.
The correlation analysis shows that there exists positive correlation between Dividend and Economic Value Added for all the companies under study with high correlation found in respect of Asian Paints Ltd, ITC Ltd.
The Relationship Between Economic Value Added and Stock Market Performance: A Theoretical Analysis, Agribusiness, 19(2), 245-253.
Economic Value Added is a measurable indicator, and so easy to compare, giving investors and the boards the opportunity to evaluate and choose between the projects being considered,
In Serbia, the application of the concept of economic value added could lead to significant improvements and developments in companies.
Economic Value Added as an indicator measures the difference between the return on company's capital and the cost of that capital (Lawrie, 2001).
The first section covers metrics of business fundamentals--many of them basic but some, like economic value added and return on invested capital, especially useful in building what Alexander in the middle section expounds as a "value performance framework.
A key metric is linking planning with some economic value measure, such as EVA or ROIC," Roth said in an interview, referring to economic value added and return on invested capital.