Cost Accounting - Economic Value Added (EVA)

Introduction

Measuring Economic Value (EVA ) is net operating profit after tax (NOPAT less the cost of the invested capital (IC ) in the business . However the measurement of EVA is widely interpreted and misinterpreted . AMP , a five billion electronic connection company , defined its own version of EVA as NOPAT / IC . There definition add value as long as their EVA was greater than cost of capital

This surveyed the measurement of EVA and its major components . The survey aimed to provide a benchmark for practitioners who are considering the adoption of EVA as

a financial performance measure . A four-page survey was mailed to 89 selected domestic EVA proponents

Findings of the Survey

of the 29 respondents to the survey measured EVA the same way . This proves that in practice there is more than one definition of EVA . There are 164 adjusting item that need to be considered especially in measuring NOPAT and invested capital . These adjustments include US GAAP based and non-US GAAP adjustments . US GAAP adjustments narrow invested capital to long term capital . Adjustments to net income remove the impact of one-time events such as interest expenses . Net assets include interest bearing debt , long-term operating liabilities and stock holders equity . Non-US GAAP adjustments

Cost of capital (COC ) is critical to the evaluation of EVA as NOPAT and IC . All 29 respondents use the Capital Asset Pricing Model (CAPM ) to calculate the cost of equity . There is a wide variety in measuring the COC . More than half of the respondents use market weights while others use book weights . Most respondents noted a targeted capital structure while some said they use the current capital structure

Conclusion

EVA is used in combination with traditional financial metrics to enhance the performance of these metrics . EVA is mainly used as a day-to-day performance measure . It is not used alone but with other financial performance measures . EVA is perceived as related to shareholder returns . EVA is linked to stock prices and to a less extent to economic or investment analysis

EVA is very dependent on accountant measures of operating income invested capital (IC ) and cost of capital (COC .Measurement of EVA varies significantly . EVA proponents make 19 adjustments on average with a range of 7 to 34 adjustments . NOPAT mostly begins as after-tax operating income with good will amortization added back . Contrary to what was expected , adjustments to align management 's views on investment in Research and Development (R D ) were incorporated 21 of the time

Invested Capital (IC ) has diverse starts . Mostly , IC starts as net assets which are equivalent to stock holders ' equity , long-term operating liabilities , and interest bearing debt . Other companies discard interest bearing debt while calculating net assets , while others do not adjust Capital Asset Pricing Model (CAPM )is mostly used to calculate the cost of capital , market versus book weightings , and current versus targeted capital structure

References

Weaver , S . Measuring Economic Value Added : A survey of the practices of EVA Proponents . Journal of Applied Finance , 2001 ,

.50-60

Measuring Economic...