What is EVA? How do you calculate the EVA? Essay

What is EVA? How do you calculate the EVA? The EVA is the incremental difference in the rate of return over a company's cost of capital. In principle, it is the value generated from funds invested in a business. (Dierks, 1997) It is after-tax net operating profit minus a capital charge. It is true economic profit consisting of all costs including the cost of capital. If a company's return on capital exceeds its cost of capital it is creating true value for the shareholder. If the total economic value added remains negative, the business should be shut down. To calculate EVA, determine the difference between the actual rate of return on assets and the cost of capital, and multiply this difference by the net investment in the business. (Accounting, 2016)
EVA Statements
The EVA main purpose is to lead manager to earn profit. The method that EVA used is base in residual income. Residual income is a performance measure normally used for assessing the performance of divisions, in which a finance charge is deducted from the profits of the division. The finance charge is calculated as the net assets of the division, multiplied by an interest rate  normally the company's weighted average cost of capital. (Nelson, 2015) The statement of EVA are helpful for calculating the inputs and assumptions. With the EVA you need to have an objective to measure the performance that can't be influenced. Having simple plans that everyone can understand are very important. Maintain a target fixed and do not changed. Having a plan that was created to work as a team is better and plan for long term plans also.
EVA Problems
Some of the problems of the EVA are that it does not have an explanation for real options or growth opportunities inherent in investment decisions. EVA seems a clear improvement over ROA and other financial ratios. However, EVA has little to offer for capital budgeting because EVA focuses only on current earnings. Another problem is that it may increase the short-term of managers. Underneath EVA, a manager will be well rewarded today if earnings are high today. Future losses may not harm the manager because there is a good chance that she will be promoted or have left the firm by then. By raising prices or cutting quality, the manager may increase current profits. However, to the extent that customer satisfaction is reduced, future profits (and, therefore, future EVA) are likely to fall. But we should not be too harsh with EVA here because the same problem occurs with ROA. A manager who raises prices or cuts quality will increase current ROA at the expense of future ROA. The problem, then, is not EVA per se but with the use of accounting numbers in general. Because stockholders want the discounted present value of all cash flows to be maximized, managers with bonuses based on some function of current profits or current cash flows are likely to behave in a shortsighted way. (Finance, 2016)