Economic Value Added





Kerry Back

Return on invested capital (ROIC)

  • Equals income divided by lagged invested capital
  • Also called return on capital employed (ROCE)
  • Some different versions
    • Adjust income for interest tax shield
    • Use average of lagged and current IC instead of lagged

Example

Year 0 1 2 3 4
Invested capital 100 70 50 35 0
Income 0 20 30 20 5
ROIC 0.2 0.428 0.4 0.143

Economic value added

  • EVA = income minus a charge for capital
  • Charge for capital = required return times lagged invested capital
  • Equivalently, EVA equals

\[(\text{ROIC} - \text{required return}) \times \text{lagged IC}\]

Example (method 1)

cost of capital = 10%


Year 0 1 2 3 4
Invested capital 100 70 50 35 0
Income 0 20 30 20 5
Charge for capital 0 10 7 5 3.5
EVA 0 10 23 15 1.5

Example (method 2)

Year 0 1 2 3 4
Invested capital 100 70 50 35 0
Income 0 20 30 20 5
ROIC 0.2 0.428 0.4 0.143
Extra return 0.1 0.328 0.3 0.043
Lagged IC 100 70 50 35
EVA 10 23 15 1.5

Discounted EVA

Year 0 1 2 3 4
EVA 10 23 15 1.50
PV factor 0.91 0.83 0.75 0.68
PV of EVA 9.09 19.01 11.27 1.02
NPV 40.39


Discounted EVA equals NPV