Economic Value Added (EVA) is a financial performance metric used to evaluate a company’s economic profit. It measures the total return on invested capital by considering both operating and financing costs. To calculate EVA, you need to find the firm’s net operating profit after taxes (NOPAT), cost of capital, and investment capital. This article will provide step-by-step instructions on how to calculate EVA.

Step 1: Determine Net Operating Profit After Taxes (NOPAT)

NOPAT is the company’s earnings generated from its core operations, adjusted for taxes. You can calculate NOPAT using the following steps:

1. Obtain the firm’s operating income (also known as operating profit or EBIT) from their financial statements.

2. Calculate the firm’s effective tax rate by dividing total income tax expense by earnings before taxes (EBT).

3. Adjust the operating income for taxes by multiplying it with (1-effective tax rate).

Formula: NOPAT = Operating Income * (1 – Effective Tax Rate)

Step 2: Calculate the Cost of Capital

The cost of capital represents the minimum return required by investors and lenders for providing funds to a company. You’ll need two types of capital costs: the cost of debt and the cost of equity.

1. Determine the company’s Weighted Average Cost of Capital (WACC) by taking a weighted average of its after-tax cost of debt and its cost of equity.

2. Weights are based on their respective proportions in the overall capital structure.

3. A simplest way to compute WACC is by looking for already calculated figures/benchmarks in company filings or equity research reports.

Formula: WACC = (% Debt * After-Tax Cost of Debt) + (% Equity * Cost of Equity)

Step 3: Determine Investment Capital

Investment Capital refers to the total capital invested in the company’s assets and operations. It can be calculated as follows:

1. Add up the book value of the company’s debt and equity (found in its balance sheet).

2. Subtract any excess cash reserves that are not required to run the business.

Formula: Investment Capital = Total Debt + Total Equity – Excess Cash

Step 4: Calculate EVA

Finally, you can calculate Economic Value Added by subtracting the weighted cost of capital from NOPAT, and then multiplying the difference by investment capital.

Formula: EVA = (NOPAT – (WACC * Investment Capital))

Conclusion:

Economic Value Added indicates whether a company is generating wealth for its shareholders and reflects its value-creation ability better than other financial metrics. By understanding how to calculate EVA, investors, analysts, and decision-makers can make more informed assessments about a company’s performance and areas for improvement.