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Economic value added (EVA) is a financial performa...

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Economic value added (EVA) is a financial performance measure based on operating income after taxes, the investment in assets required to generate that income, and the cost of the investment in assets (or, weighted average cost of capital)" ( Hock, 2009, para. 4). The use of accounting-based financial measures to assess current performance, such as return on investment (ROI), have been supplanted by the broader shareholder value-based measures of economic value added (EVA) and market value added (MVA). EVA is a value-based financial performance measure that focuses on economic value creation. Unlike traditional measures based on accounting profit, EVA recognizes that capital has two components: the cost of debt and the cost of equity. Most traditional measures, including return on assets (ROA) and return on equity (ROE), focus on the cost of debt but ignore the cost of equity. The premise of EVA is that executives cannot know whether an operation is really creating value until they assess the complete cost of capital. A company can improve its EVA by looking at strategic opportunities with high EVA prospects, efficiently managing working capital, and by structuring a initiating a stock buyback program. Additional benefits of EVA are that it can help align employee and owner interests through employee compensation plans and it can be the basis for a single competitive performance measure called market value added (MVA). EVA can be used as a metric for various internal functions, such as capital budgeting, employee performance evaluation, and operational assessment. I agree that in many cases, using EVA (instead of ROI) can lead to better management decisions. However, are there any benefits to using ROI?

 

Paper#11088 | Written in 18-Jul-2015

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