Economic Value Added (EVA)

A company may be profitable, but should the company reinvest its earnings in its business to earn more money or should it be distributed to shareholders as dividends? Should an investor purchase more stock in a secondary offering of the company? The answer depends on whether the company can earn more on the additional funds as measured by its return on assets than its opportunity cost, often represented as the aggregate return of the stock market. If it cannot earn more than the general market return with the additional funds, then investors of the company will get a lower return for their money than if they had invested in a market index fund or an exchange-traded fund based on a stock market index.

Economic value added (EVA) is the spread between a firm’s return on assets (ROA) and the opportunity cost of capital multiplied by the total amount of capital invested, and measures the amount of value added with newly invested funds.

EVA = (ROA – Cost of Capital) x Amount of Capital

EVA measures the additional value added if more money is invested in the business. If EVA is negative, then the additional investment will lower the overall return of the company.