How EVA Works

At root, EVA is just a special way to measure a firm's "economic" profit after deducting the full weighted average cost of debt and equity capital. Put another way, it is net operating profit after tax, or NOPAT, less the firm's cost of capital times its net operating assets (total assets less trade funding). The cost of capital adjustment is simple, the benefit profound. First, unlike sales, earnings, market share or EBITDA, EVA does not increase unless returns on incremental capital exceed the full cost, including the cost of giving shareholders a minimal acceptable return on their equity investment. That change alone can materially change perceptions of winning and losing businesses and strategies, and significantly improve resource allocation.

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