Understanding Economic Value Added (TM)

Economic Value Added (EVA™) is a metric used as a means of benchmarking and comparing company performance. In the simplest terms, to calculate EVA, analysts deduct the cost of capital from a company’s operating profit, adjusted for taxes on a cash basis. Much of the popularity of this metric is likely due to the successful marketing and deployment efforts of Stern Stewart & Co., the consulting company which owns the trademark. Nevertheless, this metric is backed by sound financial theory and is consistent with broader valuation principles.

EVA™=Economic Profit

Because the term Economic Value Added (EVA™) is trademarked, this tutorial will generally refer to the concept as “economic profit,” a term which is frequently substituted. For many, economic profit is shrouded in layers of complexity. Throughout the course of this tutorial, we will aim to demonstrate that the metric itself is based primarily on three straightforward principles: cash is king, some expense dollars are really investments “in disguise,” and equity capital is costly.

In order to provide some clarity on what economic profit is, we’ll explore different concepts of the metric throughout each chapter of this tutorial, demonstrating associated calculations as we go. As an example, we’ll look to the Walt Disney Co. (DIS), a publicly traded company, to build an EVA™ calculation based on real financial statements. Then, we’ll compare EVA™ to other performance metrics.

With the help of this tutorial, you’ll be able to calculate EVA™ yourself, and you’ll also develop an understanding of the strengths and shortcomings of this metric, recognizing that it is better served in some situations than others.