Economic value added (EVA) is also referred to as economic profit. It can be defined as a measure of performance of a company which focuses more on wealth or value creation for the shareholders rather than just the accounting profits. Advantages and disadvantages of EVA :
A- The EVA model applies a capital charge which corrects the key deficiencies of price multiples; that they do not incorporate the balance sheet .
A- The model recognizes through the capital charge that growth purchased with capital is not free and the capital used to purchase the growth is therefore assigned with a cost.
D- A disadvantage with the model is that if not all cash adjustments are made it can be subject to accrual distortions, as profits can be boosted by what is called harvesting the assets not reinvesting capital to maintain plant and equipment in order to improve its accrual bottom line through declining depreciation and amortization.
D- Since the EVA model relies on invested capital it can in fact be less suitable for high- growth new-economy and high-technology corporations, as Q-Cells, where there is larger risk of assets being intangible and uncorrelated with the market value of assets.
Components of EVA :
* NOPAT - Net operating profit after tax (NOPAT) is a measure of profit that excludes the costs and tax benefitsof debt financing. Put another way, NOPAT is earnings before interest and taxes (EBIT) adjusted for the impact of taxes.
* Invested capital - The total amount of money that was endowed into a company by the shareholders, bondholders and all other interested parties.
* Cost of capital – The cost of capital refer to the cost of a company's funds (both debt and equity), or, from an investor's point of view the shareholder's required return on a portfolio company's existing securities.
Economic Value Added (EVA) is important because it is used as an indicator of how profitable company projects...
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