Economic Value Added
Economic Value Added (EVA) measures the dollar amount of value a company creates above and beyond the return required by its capital providers, calculated as Net Operating Profit After Tax minus a capital charge equal to the cost of capital multiplied by invested capital.
Economic Value Added was popularized by consulting firm Stern Stewart & Co. in the 1990s and adopted by major US corporations including Coca-Cola, Eli Lilly, and SPX Corporation as a performance measurement and incentive compensation framework. The core insight is that a company can report positive accounting net income while simultaneously destroying economic value — if the return earned on invested capital falls below the cost of capital, shareholders are worse off than if they had invested their money elsewhere.
The EVA formula is: EVA = NOPAT - (WACC x Invested Capital), where NOPAT is Net Operating Profit After Tax (operating income times one minus the tax rate) and Invested Capital is the total capital deployed in the business (debt plus equity, measured at book value with various adjustments). Alternatively, EVA = (ROIC - WACC) x Invested Capital, which makes the spread between ROIC and WACC the central performance driver.
Consider a US industrial manufacturer with $500 million in invested capital, a WACC of 9%, and NOPAT of $55 million. EVA = $55M - (9% x $500M) = $55M - $45M = $10M. The company creates $10 million of value above the required return. If NOPAT were instead $40 million, EVA = $40M - $45M = -$5M, meaning the company destroys $5 million of value despite earning positive net income.
One significant appeal of EVA is that it corrects for accounting distortions. Stern Stewart identified dozens of 'accounting adjustments' — for example, capitalizing R&D expenditure (treating it as an investment rather than an expense), reversing LIFO reserves, adjusting for operating leases before ASC 842 changed lease accounting, and adding back goodwill amortization — that make EVA better reflect true economic performance. The appropriate adjustments vary by industry and company.
EVA has also influenced equity valuation. If a company earns EVA above zero, it is growing its intrinsic value; if EVA is persistently negative, destroying capital. Market Value Added (MVA) — the present value of all future expected EVA — should equal the premium or discount at which the company trades relative to its invested capital. High-MVA companies like Apple and Microsoft trade at large premiums to book value precisely because investors anticipate decades of positive EVA from their durable competitive positions.