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    Eva VS Roi

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    Safwan Bhikha
    EVA (Economic Value Added) compares net operating profit to total cost of capital to determine true profitability by accounting for the cost of all capital used. It is a better measure than ROI (Return on Investment) which only uses accounting profits and not the full cost of capital. While ROI is easier to calculate and understand, EVA aligns manager and shareholder interests by incentivizing increasing NOPAT, reducing the cost of capital, and investing where returns exceed the cost of capital. EVA shows whether a company is generating value from invested funds and is therefore superior to ROI as a performance metric.

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    Eva VS Roi

    Uploaded by

    Safwan Bhikha
    590 views12 pages
    EVA (Economic Value Added) compares net operating profit to total cost of capital to determine true profitability by accounting for the cost of all capital used. It is a better measure than ROI (Return on Investment) which only uses accounting profits and not the full cost of capital. While ROI is easier to calculate and understand, EVA aligns manager and shareholder interests by incentivizing increasing NOPAT, reducing the cost of capital, and investing where returns exceed the cost of capital. EVA shows whether a company is generating value from invested funds and is therefore superior to ROI as a performance metric.

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    EVA VS ROI

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    EVA (Economic Value Added) compares net operating profit to total cost of capital to determine true profitability by accounting for the cost of all capital used. It is a better measure than ROI (Return on Investment) which only uses accounting profits and not the full cost of capital. While ROI is easier to calculate and understand, EVA aligns manager and shareholder interests by incentivizing increasing NOPAT, reducing the cost of capital, and investing where returns exceed the cost of capital. EVA shows whether a company is generating value from invested funds and is therefore superior to ROI as a performance metric.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    590 views12 pages

    Eva VS Roi

    Uploaded by

    Safwan Bhikha
    EVA (Economic Value Added) compares net operating profit to total cost of capital to determine true profitability by accounting for the cost of all capital used. It is a better measure than ROI (Return on Investment) which only uses accounting profits and not the full cost of capital. While ROI is easier to calculate and understand, EVA aligns manager and shareholder interests by incentivizing increasing NOPAT, reducing the cost of capital, and investing where returns exceed the cost of capital. EVA shows whether a company is generating value from invested funds and is therefore superior to ROI as a performance metric.

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    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 12

    EVA v/s ROI

    ECONOMIC VALUE ADDED (EVA)


    Economic value added (EVA)isaninternalmanagementperformancemeasurethat
    comparesnetoperatingprofittototalcostofcapital

    Economicvalueadded isalsoreferredtoaseconomicprofit

    Itisimportantbecauseitisusedasanindicatorofhowprofitablecompanyprojectsareand
    itthereforeservesasareflectionofmanagementperformance

    TheideabehindEVAisthatbusinessesareonlytrulyprofitablewhenthey
    createwealthfortheirshareholdersandthemeasureofthisgoesbeyondcalculatingnet
    income

    EVAassertsthatbusinessesshouldcreatereturnsatarateabovetheircostofcapital
    WHY IT MATTERS:
    EVAisimportantbecauseitisusedasanindicatorofhowprofitablecompany

    projectsareanditthereforeservesasareflectionofmanagementperformance.

    Itincludesthebalancesheetinthecalculationandencouragesmanagerstothink

    aboutassetsaswellasexpensesintheirdecisions.

    EVAonlyappliestotheperiodmeasured;itisnotpredictiveoffutureperformance,

    especiallyforcompaniesinthemidstofreorganizationand/orabouttomake

    largecapitalinvestments.
    TheEVAcalculationdependsheavilyoninvestedcapital,anditisthereforemostapplicabletoasset-
    intensivecompaniesthataregenerallystable.
    Thus,EVAismoreusefulforautomanufacturers,forexample,thansoftwarecompaniesorservice
    companieswithalotofintangibleassets.

    EVA = Net Operating Profit After Tax - (Capital Invested x Weighted Average Cost of Capital)

    Example
    AssumethatCompanyXYZhasthefollowingcomponentstouseintheEVAformula:

    NOPAT=Rs.33,80,000
    CapitalInvestment=Rs.13,00,000
    WACC=.056or5.60%

    EVA = Rs.33,80,000 - (Rs.13,00,000 x .056) = Rs.33,07,200


    Return On Investment (ROI)
    ROIistheratioofaprofitorlossmadeinafiscalyearexpressedintermsofan
    investmentandshownasapercentageofincreaseordecreaseinthevalueofthe
    investmentduringtheyearinquestion

    Itmeasuresthegainorlossgeneratedonaninvestmentrelativetotheamount
    ofmoneyinvested

    ROIisusuallyexpressedasapercentageandistypicallyusedforpersonalfinancial
    decisions,tocompareacompany'sprofitabilityortocomparetheefficiencyof
    differentinvestments

    http://study.com/academy/lesson/return-of-investment-definition-formula-example.html
    WHY IT MATTERS:
    ROIisoneofthemostusedprofitabilityratiosbecauseofitsflexibility
    OneofthedownsidesoftheROIcalculationisthatitcanbemanipulated,soresultsmayvarybetweenusers
    WhenusingROItocompareinvestments,it'simportanttousethesameinputstogetanaccuratecomparison

    ROI = (Net Profit / Cost of Investment) x 100

    Forexample,aninvestorbuysRs.1,000worthofstocksandsellsthesharestwoyearslaterforRs.1,200.
    ThenetprofitfromtheinvestmentwouldbeRs.200andtheROIwouldbecalculatedasfollows:

    ROI = (200 / 1,000) x 100 = 20%


    http://www.investinganswers.com/financial-dictionary/technical-analysis/return-investment-roi-1100
    Difference between ROI and EVA
    ROI EVA
    ROIisbasedonaccountingprofits EVAisbasedoneconomicprofits

    ROIestablishesrelationshipbetween EVAmakesadjustmentsforaccountingprofit
    accountingprofitandaccountinginvestments andaccountinginvestments

    ROIisbasedonaccountingprinciples EVAdeviatesfromaccountingprinciples

    ROIdonotconsidercostofcapital EVArecognizescostofcapital

    ROIcanprovidebasisofcomparison EVAdonotcomparewithotherorganization

    ROIisbesttomeasurecompanieswith EVAisbesttomeasurecapitalintensive
    intangibleassets companies
    Advantages and Disadvantages of
    EVA and ROI
    Advantages of ROI

    1. Itrelatesnetincomewithinvestmentswhichgivesbettermeasureofdivisionalprofits.

    2. MajorfocusofROIisonrequiredlevelofinvestments.

    3. ROIhelpsinmakingcomparisonbetweendifferentbusiness.

    4. Easytocalculateandeasytounderstand

    Disadvantages of ROI

    5. ROIisbasedonhistoricalcostifassets

    6. ROIprovidesfocusonshorttermresultsandprofits

    7. ROIconsidercurrentperiodrevenueandcost
    5.InvestmentCentremanagerscaninfluenceROIbychangingaccountingpolicies

    6.Satisfactorydefinitionofprofitandinvestmentisdifficulttofind

    Advantages of EVA

    1. EVAcoversbothoperatingcostaswellascapitalcost

    2. EVAcanevaluateprojectsindependentlyandhencedecideonwhethertoexecutetheprojectornot

    3. Ittransformaccountinginformationintoeconomicquality.

    4. EVAshoesrelationshipbetweenoperatingmarginintenseuseofcapitalsothatcanidentify
    opportunitiesofimprovement.
    Disadvantages of EVA

    1. EVAdoesnotinvolveforecastoffuturecashflows

    2. EVAisverycomplicatedtocalculate.

    3. EVAdoesnottakeaccountingprinciplesintoconsideration
    EVA is superior to ROI
    WhatseparatesEVAfromotherperformancemetricsisthatitmeasuresallofthecostsofrunningabusiness
    operatingandfinancing.
    ThismakesEVAthesoundestperformancemetricandtheonemostcloselyalignedwiththecreationof
    shareholdervalue.
    Manycompanieshaveadopteditaspartofacomprehensivemanagementandincentivesystemthatdrives
    theirdecisionprocesses.
    TheystrivetoincreasetheirEVAby:
    IncreasingtheNOPATgeneratedbyexistingCapital
    ReducingtheWACC
    InvestinginnewprojectswheretheReturnonCapital
    exceedstheWACC
    DivestingCapitalwheretheReturnonCapitalisbelow
    theWACC
    AcompanythataimstomaximizeitsROIwillalwaystendtounderinvest,under-innovate,under-scale,
    andunder-grow.
    EVAeasilyhelpsaproductionmanagertofigureoutwhetheritisworthwhiletoinvestcapital.
    EVAistheonlymeasurethatestablishesasearingdividinglinebetweengoodandbadperformancefor
    itisthetruemeasureofprofit.
    ApositiveEVAshowsacompanyisproducingvaluefromthefundsinvestedinit.
    NegativeEVAmeansthecompanyisnotgeneratingvaluefromthefundsinvestedintothebusiness.A
    negativeEVA,inotherwords,reflectstheimpactofpriordecisionsandsunkcoststhatarebynow
    irrelevant.
    AftermakingthenecessarychangesifEVAstillremainsnegative,thenitwouldbebesttoshutdownthe
    business.
    Itgivesmanagersalloftherightincentivestomakethedecisionsatthemarginthatwillcreatethemost
    shareholdervalue.

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