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Running head: ECONOMIC VALUE ADDED (EVA)

Economic Value Added (EVA) Shelon Post American Public University

ECONOMIC VALUE ADDED (EVA) Abstract The EVA in a corporation perspective, within its collective uses is an imperative tool for examining financial statements. The EVA is the most successful performance metric system utilized by corporation financial consultants improving the corporation financial status. Stern Stewart developed and marketed the EVA metric system, which is a reasonable and sound financial theory and reliable with evaluation principles. Economic Value Added (EVA) measures the amount of money in dollars a business is earning after deducting the cost of capital. EVA is used as a financial management system that allows managers and employees to focus on how

capital is used and the cash flow generated from it. Concepts which are important for all investor's analysis of a corporation, however, there is problems found with the EVA financial system.

Economic Value Added (EVA)

ECONOMIC VALUE ADDED (EVA) All corporations have similar goals when it comes to obtaining capital and an earning rate of return, which will exceed the return offered by others of capital funds. Economic Value Added (EVA) measures the amount of money in dollars a business is earning after deducting the cost of capital. EVA is used as a financial management system that allows managers and employees to focus on how capital is used and the cash flow generated from it. A firm can do a better job of asset management and EVA can be used to hold the organization accountable for all economic

outlays whether they appear in the income statement, on the balance sheet or in the footnotes to the financial statements. This is possible because EVA creates one financial statement that includes all the costs of being in business, while making managers aware of every dollar they spend. EVA statements improve financial statement reporting, results, and success because there are benefits from focusing on growth in EVA. This is because the focus of the firms attention is towards its key responsibility, which is increasing investors wealth and cost. This frees the firm to spend more time finding ways to increase EVA, in turn producing extra shareholder value. Another benefit of using EVA is that the EVA improves the corporations financial statement and creates a verbal communication for making long-term decisions. Business accountants depict income statements by starting with the company revenues and deducting operating and other costs. However, the cost of the capital raised by the company from investors is not on the statement. Therefore, the firm needs to measure the companies earned income as a profit after deducting cost of capital and all other costs. The company cost of capital is the expected return on a portfolio of all the companys existing securities. It is the opportunity cost of capital for investment in the firms assets, and therefore the appropriate discount rate for the firms average-risk projects. If the firm has no debt outstanding, then the company cost of capital is

ECONOMIC VALUE ADDED (EVA) just the expected rate of return on the firms stock. Each project needs evaluated at its own opportunity cost of capital (Brealey, Myers, & Allen (2011). Problems with EVA The problem with EVA is it does not have an explanation for real options or growth opportunities inherent in investment decisions. In addition, Eva does not reflect the markets perception of the value of growth opportunities. EVA is most appropriate for evaluating corporations with extensive assets and few growth opportunities. The more assets the firm has to

work with, there is a greater opportunity to generate a large EVA. The manager of a small division may be highly competent, but if that division has few assets, she is unlikely to rank high in the EVA stakes. Conclusion Executing value-added measures into any corporation is costly and a timely development. Optimizing the corporations strategy for value creation and transition to value-added measurements requires serious commitment. This requires extensive training and communication with everyone in the business. Education on the basic theory underlying the notion of creating economic value is necessary for all involved with the corporation.

Reference

ECONOMIC VALUE ADDED (EVA) Brealey, R. A., Myers, S. C., & Allen, F. (2011). Principles of corporate finance (2nd ed.). New York, NY: McGraw-Hill IrwinDe Freitas, Z. (2002). MANAGEMENT AND ACCOUNTING WEB. Retrieved April 21, 2012 from http://maaw.info/ArticleSummaries/ArtSumDierksPatel97.htm Oded, J., & Michel, A. (2009). Why Does DCF Undervalue Equities?. Journal Of Applied Finance, 19(1/2), 49-62.