Q.1. Define EVA & ROI? What are the differences between EVA and ROI? ECONOMIC VALUE ADDED (EVA) Economic Value Added (EVA) term was formed & Introduce by a New York Consulting firm, Stern Steward & Co in 1982 to boost the value-maximizing behavior in corporate managers. Economic Value Added (EVA) term has been used in the book named “The Quest for Value” which was published in 1991. Basically EVA is a value-based measure that was designed to evaluate the business strategies, capital projects and to increase the long-term shareholder’s wealth. Economic value added (EVA) is a measure of a company's financial performance based on the residual wealth calculated by deducting its cost of capital from its operating profit, adjusted for taxes on a cash basis. EVA can also be referred to as economic profit, and it attempts to capture the true economic profit of a company. The ECONOMIC VALUE ADDED (EVA) formula is: EVA=Net profit- Capital charge Where, Capital charge = Cost of capital * Capital employed

Return on investment (ROI) Return on investment (ROI) measures the gain or loss generated on an investment relative to the amount of money invested. ROI is usually expressed as a percentage and is typically used for personal financial decisions, to compare a company's profitability or to compare the efficiency of different investments. The return on investment formula is: ROI = (Net Profit / Cost of Investment) x 100 For example, an investor buys $1,000 worth of stocks and sells the shares two years later for $1,200. The net profit from the investment would be $200 and the ROI would be calculated as follows: ROI = (200 / 1,000) x 100 = 20%

Difference between ROI and EVA Subject Meaning

EVA EVA is the residual profit after taking into the capital charge.

ROI ROI is the comparison of the income generated with the assets employed.

Measure Measuring Tool

EVA is an absolute measure.

ROI is a relative measure.

Thought Way to express result

EVA is performance measuring ROI is an ing tool. measuring tool. EVA is an advanced thought. ROI is in accordance with tradition. EVA is in currency. ROI is described in term of percentage.

Superiority

Conceptually EVA is superior Conceptually EVA is superior than ROI than ROI

Cost of capital Profit used for Calculation Profit before interest and tax is Formula for Calculation

used. EVA = Net Operating Profit After Tax – (Operating Assets* Cost of Capital)

Profit after interest and tax is used. ROI = Earnings Before Interest and Tax (EBIT) / Capital Employed

Q.3. How do you Calculate Economic Value Added? Give some Examples. Net Sales Operating Expenses ___________________________ Operating Profit (EBIT) - Taxes ___________________________ Net Operating Profit After Tax (NOPAT) - Capital Costs (Total Capital x Cost of Capital) ___________________________ Economic Value Added

4 Steps to Calculate Economic Value Added i) Calculate Net Operating Profit after Taxes Gross Sales = $1,000,000 Operating Expenses = $350,000 Depreciation = $100,000 Taxes = $150,000 Net Operating Income = $1m - $350k - $100k - $150k = $400,000

ii) Determine total Capital deployed in the business Total Capital = Net Working Capital + Net Fixed Assets Total Capital = $300,000 + $1.2m Total Capital = $1,500,000

iii) Calculate Weighted Average Cost of Capital Assume WACC = 12%

iv) Calculate Capital cost to NOPAT & Economic Value Added Capital Costs = Total Capital x Cost of Capital Capital Costs = $1,500,000 x 0.12 Capital Costs = $180,000 Economic Value Added = Net Operating Income - Capital Costs Economic Value Added = $400,000 - $180,000 Economic Value Added = $220,000

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