Using EVA

Economic Value Added (EVA) is a frequently used ratio by investors from developed market economies. The basic idea of this formula is based on the foundation that the main goal of a company is to maximize profit. However it does not mean book profit (the difference between revenues and costs) but economical profit.

The difference between economical and book profit is that economical profit is the difference between revenues and economical costs, which are book costs and opportunity costs. Opportunity costs are presented by the amount of money lost by not putting available sources (like capital, labor, etc.) to the best alternative use. This relation is possible to describe in following way:
Book profit = Revenues – Costs
Economical profit = Total revenues from capital – Costs of capital

A basic construction of EVA measure is clear from the following formula:
EVAt = NOPATt – Ct x WACCt
where NOPATt is Net Operating Profit After Tax,
Ct is long term capital,
WACC is Weighted Average Cost of Capital

If EVA > 0, then we can say a company is successful. This is the only case when wealth of shareholders increases because they gain more than what they put in originally. In case EVA = 0, a company produced just as much as it was invested and EVA less than 0 leads to destroying of shareholders' wealth.

Companies which can gain the highest level of profit (NOPAT) while using minimum "cheap” capital will experience positive results. It is possible when investments are consistently driven by criteria of net present value. Therefore EVA represents an interesting measure of judging the performance of companies.