Final answer:
Economic Value Added (EVA) measures a company's economic profit by calculating the value generated in excess of the required return of the company's shareholders. The formula for EVA is NOPAT minus the product of invested capital and the weighted average cost of capital (WACC). It shows whether the company has created excess value over the financing costs.
Step-by-step explanation:
Economic Value Added (EVA) is a performance metric that measures a company's economic profit. It represents the value created in excess of the required return of the company's shareholders. Essentially, it is the profit earned by the company after subtracting the cost of financing the company's capital. The formula to calculate EVA is:
EVA = Net Operating Profit After Taxes (NOPAT) - (Invested Capital x Weighted Average Cost of Capital (WACC))
Where NOPAT is calculated by taking the company's operating profit and adjusting for taxes, and Invested Capital represents the total amount of capital invested in the business (both debt and equity).
The WACC is the average rate of return a company is expected to pay to its security holders to finance its assets. For example, if a company has a NOPAT of $1,000,000, invested capital of $10,000,000, and a WACC of 10%, the EVA would be:
EVA = $1,000,000 - ($10,000,000 x 0.10) = $1,000,000 - $1,000,000 = $0
This means that the company has not created any excess value over the cost of financing its capital during that period.