What is the formula for Economic Value Added (EVP)?

What is the formula for Economic Value Added (EVP)?

• A. Net Operating Profit after Taxes - (Invested Capital x Cost of Capital)
• B. Net Earnings - (Total Assets x Cost of Equity)
• C. Operating Income - (Net Earnings x Cost of Debt)
• D. Net Earnings - (Capital x Total Revenue)

Answer: (A)

The formula for Economic Value Added (EVA) is accurately represented by the first option: Net Operating Profit after Taxes - (Invested Capital x Cost of Capital). This formula is essential for measuring a company's financial performance and the value it generates over its cost of capital. EVA is derived from the concept that to create value for shareholders, a company must earn more than its cost of capital. The first part of the formula, Net Operating Profit after Taxes (NOPAT), reflects the profit a company makes from its operations after tax expenses, providing a clear picture of operational efficiency. The second part, which involves multiplying the invested capital by the cost of capital, represents the required return that investors expect from their investment in the company. By subtracting the capital charge (the cost) from the NOPAT, we can ascertain whether the company is generating excess value—or economic profit—above and beyond the expected return. This concept is crucial in evaluating business performance and guiding strategic decision-making in areas like compensation and investments, making it an integral part of business acumen for compensation professionals.

The formula for Economic Value Added (EVA) is accurately represented by the first option: Net Operating Profit after Taxes - (Invested Capital x Cost of Capital). This formula is essential for measuring a company's financial performance and the value it generates over its cost of capital.

EVA is derived from the concept that to create value for shareholders, a company must earn more than its cost of capital. The first part of the formula, Net Operating Profit after Taxes (NOPAT), reflects the profit a company makes from its operations after tax expenses, providing a clear picture of operational efficiency. The second part, which involves multiplying the invested capital by the cost of capital, represents the required return that investors expect from their investment in the company. By subtracting the capital charge (the cost) from the NOPAT, we can ascertain whether the company is generating excess value—or economic profit—above and beyond the expected return.

This concept is crucial in evaluating business performance and guiding strategic decision-making in areas like compensation and investments, making it an integral part of business acumen for compensation professionals.