Economic Value Added

Topics: Time, Economics, Rate of return Pages: 4 (1248 words) Published: July 30, 2013
How important is it for firms to focus on the value added concept?

Definition of Value Added concept:
The enhancement a company gives its product or service before offering the product to customers. Value added is used to describe instances where a firm takes a product that may be considered a homogeneous product, with few differences (if any) from that of a competitor, and provides potential customers with a feature or add-on that gives it a greater sense of value.

* EVA is calculated as following:

EVA=Net Operating Profit after Tax (NOPAT) – Capital Cost
Importance:
* Compared to ROE, EVA includes the concept of capital cost, shows the amount of value creation, and includes the concept of balance sheet. This is the advantage of EVA. * The significant difference of ROE from EVA is that ROE does not include the concept of capital cost. Because calculation of EVA deducts capital cost from NOPAT, the result of EVA is shown by amount, not in percentage. This makes it clear to understand that profit of the company is exceeding capital cost if EVA is positive, and profit of the company is under capital cost if EVA is negative. * EVA is also considered to have less influence by the change in accounting policy of the company. This is because profit volatility by the changing accounting policy is offset due to increase or decrease of invested capital in Balance Sheet at the same time. * Economic Value Added (EVA) is important because it is used as an indicator of how profitable company projects are and it therefore serves as a reflection of management performance. * The idea behind EVA is that businesses are only truly profitable when they create wealth for their shareholders, and the measure of this goes beyond calculating net income. Economic value added asserts that businesses should create returns at a rate above their cost of capital * The economic value calculation has many advantages. It succinctly summarizes how much and from...
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