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Strenghs, Weakness and Uses of the Economic Balue Added - Essay Example
Finance & Accounting
Pages 6 (1506 words)
Running head: STRENGTHS, WEAKNESSES AND USES OF THE ECONOMIC VALUE ADED MODEL Strengths, weaknesses and uses of the Economic Value Added Insert Name Insert Insert 22nd November 2011 Introduction Economic Value Added (EVA) model also referred to as economic profit refers to the value created above the shareholders investment…
This paper candidly evaluates the uses of Economic Value Added model in a business as well as its strengths and weaknesses. Uses of EVA EVA is obtained by subtracting the cost of capital from Net Operating Profit After Tax (NOPAT).In this regard, Al Ehrbar (2008) depicts that it is a useful tool for measuring the extent to which value has been lost or added on the business performance. After accounting for the various aspects covered by the balance sheet, EVA indicates the amount of the residual income. There are various factors that cause an increase of EVA. First, if capital employed does not increase and the NOPAT increases. Secondly, EVA increases if the additional capital invested generates more returns than the cost of capital. EVA can also increase if the capital that was earlier invested in a business is divested if it fails to cover the cost of capital used by a business. Economic Value Added=Operating income obtained after tax-(Investment in assets * weighted average cost of capital) (Bennett, 1991). If the EVA figure is negative, it means that a business is consuming more capital instead of creating wealth. On the other hand, a positive EVA indicates that the company has earned more after tax revenue than the costs incurred in generating that revenue. ...
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