Economic Value Added (EVA)

EVA is an overarching measure originally coined by Stern Stewart & Co and is used to measure the wealth generation potential of the company. The EVA of the company is defined as:

The opening capital (debt and equity) X The performance spread

Where the Performance spread = Return on Investment X WACC

A positive EVA indicates wealth generation. Conversely a negative EVA indicates wealth destruction. Over the years a number of issues arising from the use of Eva have been ironed out including the treatment of befits and costs.

Forecasting EVA creates the concept of Market Value Added which is defined as the present value of future EVA’s.

Key benefits of using EVA are:

It forces the company to shift away from managing its profits to managing its wealth by permitting the company to monitor and measure wealth generation.
This in turn allows EVA to be used as a measure of management efficiency. Many companies accordingly link the EVA to reward and remuneration strategies for key managers and staff.
It permits forward plans to project future EVA’s instead of future profits and in well constructed EVA based plans forces managers to focus on wealth creation instead of short term cash profits.