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Economic Value Added (EVA)

It is a popular measure currently being used by several firms to determine whether an existing/proposed investment positively contributes to the owners/shareholders wealth. The EVA is equal to after-tax operating profits of a firm less the cost of funds used to finance investments: A positive EVA would increase owners value/wealth. Therefore, only . investments with Positive EVA would be desirable from the viewpoint of maximizing shareholders wealth. To illustrate, assuming an after-tax profit of Rs.40 crore and associated costs of financing the investments of Rs.38 crore, the EVA = Rs.2 crore (Rs,40 crore – Rs.38 crore), With a positive. EVA, the investment would add value and increase the wealth of the owners and should be accepted. The computation of the after-tax operating profits attributable to the investment under consideration as well as the cost of funds used to finance it would, however, involve numerous accounting and financial issues.

The merits of EVA are: (a) its relative simplicity and (b) its strong link with the wealth maximization of the owners. It prima facie exhibits a strong link to share prices, that is, positive EVA is associated with increase in prices of shares and vice verse. However, EVA is, in erred, a repackaged and well-marketed application of the EVA technique of investment decision. But EVA is certainly a useful tool for ope-rationalizing the owners value maximization goal, particularly with respect to the investment decision.

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