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
Economic Value Added Kerry Back