Economic Value Added (EVA) is calculated as which of the following?

Economic Value Added (EVA) is calculated as which of the following?

• A. NOPAT minus (WACC multiplied by invested capital).
• B. Net income minus taxes.
• C. Cash flow from operations minus capital expenditures.
• D. Gross profit minus operating expenses.

Answer: (A)

Economic Value Added measures value creation by comparing operating profits after tax to the cost of capital. It uses NOPAT, which is the after-tax profit from operations, and subtracts the cost of the capital tied up in the business. That cost is the invested capital multiplied by the weighted average cost of capital (WACC). So EVA = NOPAT − (WACC × invested capital). If EVA is positive, the firm earns more from its operations than the minimum return required by its providers of capital; if negative, value is not being created. This differs from the other measures because net income minus taxes is just after-tax accounting profit and doesn’t account for the financing cost of the capital used. Cash flow from operations minus capital expenditures is a cash-flow metric, not a measure of value created above capital cost. Gross profit minus operating expenses yields operating income (EBIT), which again ignores the cost of capital.

Economic Value Added measures value creation by comparing operating profits after tax to the cost of capital. It uses NOPAT, which is the after-tax profit from operations, and subtracts the cost of the capital tied up in the business. That cost is the invested capital multiplied by the weighted average cost of capital (WACC). So EVA = NOPAT − (WACC × invested capital). If EVA is positive, the firm earns more from its operations than the minimum return required by its providers of capital; if negative, value is not being created.

This differs from the other measures because net income minus taxes is just after-tax accounting profit and doesn’t account for the financing cost of the capital used. Cash flow from operations minus capital expenditures is a cash-flow metric, not a measure of value created above capital cost. Gross profit minus operating expenses yields operating income (EBIT), which again ignores the cost of capital.