Economic Value Added (EVA)
Introduction
Economic Value Added (EVA) -- a name trademarked by Stern Stewart & Co. - subtracts the capital charge (the capital investment times the cost of capital) from the net financial benefits of the investment. Economic profit is wealth created above the capital cost of the investment. EVA prevents managers from thinking that the cost of capital is free. EVA focuses managers on the question, "For any given investment, will the company generate returns above the cost of capital?" Companies that embrace EVA have bonus compensation schemes that reward or punish managers for adding value to or subtracting value from the company. As with any metric, it's hard to link precise EVA returns to a specific technology investment. EVA is ideally suited to publicly traded companies, not private companies, because it deals with the cost of equity for shareholders, as opposed to debt capital.

If a company invests in manufacturing equipment or a warehouse, how much additional profit will be required to pay for it? Managers are intuitively aware of the importance of value creation to their businesses. EVA is a management philosophy and performance metric that elevates those goals from intuition to rigorous analysis and ensures that no investment escapes scrutiny.

Yes, that includes IT. The fundamental proposition of EVA is that capital isn't free and its cost must be factored into every benefit analysis or return-on-investment model when an investment in a plant, equipment or a new customer relationship management system is contemplated.

The pure EVA calculation for the company as a whole is:

Net operating profit after taxes - capital charge (capital investment x cost of capital)

Consider, for instance, a case where the cost-benefit analysis reveals that a $50,000 IT investment will return $8,000 in net quantifiable benefits. The ROI is 16% ($8,000 divided by $50,000). The cost of capital in the company is 12%. Using the formula above, the EVA in this case is $2,000:

$8,000 net benefits - ($50,000 capital investment x 12% cost of capital) = $2,000 EVA

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