Final answer:
The two alternative ways to estimate an entity's EVA are the Top-down approach and the Bottom-up approach, which focus on the calculation of true economic profit by considering both explicit and implicit costs, in contrast to solely accounting profit.
Step-by-step explanation:
Two alternative ways to estimate an entity's EVA are the Top-down approach and the Bottom-up approach. The Economic Value Added (EVA) is a measure of a company's financial performance based on the residual wealth calculated by deducting the cost of capital from its operating profit. This calculation adjusts for the opportunity costs of capital investment and aims to measure true economic profit.
Understanding the conception of profit is crucial when discussing EVA. We differentiate between accounting profit and economic profit. Accounting profit is the total revenue minus explicit costs, representing the difference between dollars brought in and dollars paid out—essentially a cash concept.
In contrast, economic profit considers both explicit and implicit costs, representing total revenue minus total cost. This concept is important because it reflects whether a business is economically successful, which isn't solely determined by accounting profit.
For example, if a firm's total revenues are $1,000,000 and the explicit costs are $600,000, $150,000, and $200,000, then the accounting profit would be $50,000. However, if the implicit costs amount to $30,000, the economic profit would be $20,000. These calculations are paramount when considering the true profitability of a business, especially when it comes to calculating EVA.
Therefore, the correct answer is Option 2: Top-down; Bottom-up.