By James Bell
Economic Value Added (EVA) is a profit metric. It was created by the consulting firm Stern Value Management. The big difference between EVA and regular profit is that EVA takes into account the cost of capital. It shows the amount of economic value added with a positive value or destroyed with a negative value.
This is economic profit which many consider to be the true profit of a company or project. Capital, or money, isn’t free so how it is spent should at least cover the cost paid for that capital. Using EVA as a metric to measure performance of executives and managers can help increase the incentives to perform better and can be part of guiding incentive compensation systems.
Net Operating Profit After Tax
Weighted Average Cost of Capital
We need two things to calculate NOPAT. The first is the tax rate and the second is EBIT. EBIT stands for Earnings Before Interest and Taxes. Keeping interest out of the equation helps us focus on the operational performance. Including leverage would create noise and is really a different conversation to have in a separate context.
Here is how you calculate NOPAT
Earnings Before Interest and Taxes.
This could come from historical data or what you expect the tax rate to be.
We can get this number in a couple of ways. We can take Total Assets – Current Liabilities or we add Long Term Debt and Equity and get the same answer. This is our investment if we are using EVA to evaluate a project or program.
We are using WACC as the rate that we multiply by our Capital Employed that we then subtract from our NOPAT to see if we’ve added or destroyed economic value. Remember that Positive EVA’s add value, negative EVA values destroy value.
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