How is economic value added (EVA) calculated?

Economic Value Added (EVA) is a measure of a company's financial performance that indicates how much value is being created beyond the required return of the company's shareholders. The calculation involves taking the net profit of the company and subtracting the cost of capital, which reflects the opportunity cost of investing capital elsewhere.

To break it down further:

1. Net Profit represents the actual earnings generated from operations after all expenses have been deducted.

2. Cost of Capital denotes the return that investors expect from their investment in the company, which includes both equity and debt costs. This is crucial because it reflects the minimum return needed to satisfy shareholders and cover the costs of borrowed funds.

When you subtract the cost of capital from the net profit, you're essentially assessing whether the company is generating returns that exceed its capital costs. If the result is positive, it indicates that the company is creating wealth for shareholders; if it's negative, the company is not generating enough return to cover capital costs.

Thus, this approach quantitatively measures whether the company is creating or destroying value, making it a powerful tool for performance assessment.