How is economic value added (EVA) calculated?

Economic Value Added (EVA) is a measure of a company's financial performance that focuses on the value created beyond the required return of the company's shareholders. The correct method for calculating EVA involves deducting the cost of capital from the company's operating profit, which reflects the profit generated from its core business operations.

Operating profit, often referred to as net operating profit after taxes (NOPAT), is the profit a company earns from its operations without considering the cost of financing. The cost of capital represents the return necessary to satisfy both equity and debt holders. By subtracting this cost from operating profit, EVA indicates whether a company is generating value over and above what investors expect for their investments. A positive EVA suggests that the company is creating value for shareholders, while a negative EVA indicates that it is not meeting its cost of capital.

Thus, this method demonstrates the effectiveness of management in generating profits and making investment decisions that lead to shareholder wealth creation.