Question

Economic value added (EVA) is equal to EBIT(1 - T), or NOPAT, minus the dollar cost of all the firm's total invested capital. The primary difference between EVA and accounting net income is that only the cost of debt (interest charges) is deducted when calculating accounting net income whereas the cost of common equity is also deducted when finding EVA. True or false?

Answer 1

The statement is true; EVA subtracts the cost of all capital, including equity, unlike accounting net income which only subtracts the cost of debt. This reflects the distinction between accounting profit and economic profit, where the latter also includes implicit costs.

Step-by-step explanation:

The statement that Economic Value Added (EVA) is calculated by subtracting the dollar cost of all the firm's total invested capital from NOPAT (Net Operating Profit After Tax), and that it considers the cost of both debt and equity, unlike accounting net income which only considers the cost of debt, is true. In financial analysis, it's important to differentiate between the concepts of accounting profit and economic profit. Accounting profit is calculated as total revenue minus explicit costs, or the actual cash transactions. Economic profit, however, includes both explicit costs and implicit costs, which reflect the opportunity costs of a company's resources. Thus, while EVA is a measure of economic profit, accounting net income is a measure of accounting profit. A firm's economic success is better indicated by its economic profit as it provides a more comprehensive view of the firm's profitability by taking into account the cost of capital, including equity.