A Comparison of EVA and NPV

Topics: Corporate finance, Economic value added, Value added Pages: 17 (3869 words) Published: September 30, 2013
Running head: A COMPARISON OF EVA AND NPV

A Comparison of EVA and NPV (discuss the differences and similarity of EVA and NPV; why would companies choose to adopt EVA, implementation issues; chronicle the implementation experience of EVA on a real life company).

1
 

A COMPARISON OF EVA AND NPV

2
 

A Comparison of EVA and NPV (discuss the differences and similarity of EVA and NPV; why would companies choose to adopt EVA, implementation issues; chronicle the implementation experience of EVA on a real life company).

Finance executives are required not only to crunch numbers and generate forecast but to think ‘critically’, not just seeing the numbers but understanding their implications. This is what Melon (1994) refers to as conducting a ‘financial assessment’ which often involves; the comparisons of the firm’s profitability in relation to its competitor, a determination of the magnitude of its investment, estimating the likelihood of premiums, and projecting the impact stockholders may sustain.(Melone, 1994, p. 454)

While all sectors of an organization contribute to its success, it is the finance department that often drives major decisions. Do we invest, can we afford to invest, and if so, how much? This is a basic example of the type of questions asked frequently of a finance executive. Through analysis of the ‘numbers’ generated by the accounting department, or by conducting a financial assessment of the organization, finance executives are often able to guide the decision making process, and in ideal situations, generate revenues and growth for their company. This of course, is not to imply that the finance department has the final say, according to Melone (1994), “decision making at the organizational level involves integration, considering ‘all’ the issues raised by executives in various roles, considering ‘all’ the lines of reasoning that might be generated, and deciding how best to combine the collective knowledge and beliefs” (Melone, 1994, p. 439).

This informative paper will review academic literature to draw a comparison between two financial ‘theories’, EVA (Economic Value Added) and NPV (Net Present Value). Arranged in four sections, this paper will: (1) define EVA and NPV highlighting their

A COMPARISON OF EVA AND NPV

3
 

similarities and differences; (2) explain why companies choose to adopt EVA; (3) discuss some of the issues faced when implementing EVA; (4) and finally chronicling ‘McKee Foods Corporation’s’ experience while implementing EVA.

Similarities and Differences between EVA (Economic Value Added), and NPV (Net Present Value).
Defining EVA; its role, application and calculation:
Baran, Hrotko and Olejník (2007) noted that, towards the latter half of the 20th century more specifically during the last decade, there were more common and vehement objections to the ‘classical’ profitability indicators. (Baran, Hrotko & Olejník, 2007, p. 669) In response, Stern Stewart & Co. an American consultancy firm developed two new evaluation criteria’s for measuring a company’s output; Economic Value Added (EVA, also known as residual income, operating profit less a capital charge or economic profit) and the Market Value Added (MVA). (Baran et al., 2007, p. 669; Cagle, Smythe & Fulmer, 2003, p. 65)

According to Morris (2001), Cost of capital, also known as the required rate of return, is considered a basic building block of the EVA system. (Morris, 2001, p.106) EVA, is calculated by multiplying the firm’s capital by its weighted average cost of capital (WACC) and subtracting the total from the net operating profit after taxes (NOPAT) i.e.; EVA =NOPAT - Capital *WACC (see figure 1 and 2). (Baran et al., 2007, p. 669) According to Baran et al. (2007), EVA is an expression of economic profit by a difference between capital and revenues; “[EVA is] understood as a net revenue from the operating activity of a company reduced by costs of the capital (own and foreign)” (Baran et al.,...
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • Npv Comparison Essay
  • npv Essay
  • The Comparison of Irr and Npv Essay
  • npv and irr Essay
  • NPV AND IRR Essay
  • Eva Analysis Essay
  • Npv Assignment Research Paper
  • Essay about KS EVA

Become a StudyMode Member

Sign Up - It's Free