Economic Value

EVA is a risk-adjusted quantitative measure of project performance. Unlike the previous measur The idea of EVA is that a project should earn more in profits than the cost of the project's capita employed is the liability or equity (resources "owned" by creditors and owners) that finances the project were less profitable than the cost paid for its capital employed, then the creditors and ow their capital elsewhere. Such a competitive rationale should be a component of any rational deci

When working with EVA we use the same risk factors and notation as already developed. The c discount rate, "k":

The cost of capital employed ($CCE) = k * $Capital employe

Thus, if a project absorbs $100,000 in capital for a year, and the risk factor, CCF, is 8%, then the earnings must exceed $8,000 or else more is being spent on capital than is being earned on the time frame for comparison of earnings and CCE should be identical or else each is subject to dif to discount all figures to present time for a common comparison.

The first step in looking at EVA is to get a handle on earnings. Earnings are profits and they are P&L would show:

(Revenues - Cash expenses - Noncash expenses) * (1 - Tax rate) = Earning

Immediately we see that noncash expenses save real cash outlays on taxes by subtracting from we will assume the noncash expense is depreciation of capital assets and that the revenue is fro

If we then sum up the EAT for each period and compare the summed EAT to the CCE, we have

To put EVA in a project context, consider Table 5-8. We assume a $500,000 capital investment straight-line depreciation of $100,000 per year. [91 Our capital investment on the balance sheet is terminology for "reduced") by a depreciation expense each year; each year the capital employed accordingly, and the CCE is less each year as well. Each year we multiply the investment balanc of capital factor, k, to calculate the cost of capital for that year. Discounting by 1/(1 + k)N each ye cost of capital employed (PV CCE).

Table 5-8: Depreciation in EVA Example

Present

1

2

3

4

5

$0.00

$100,000.00

$100,000.00

$100,000.00

$100,000.00

$100,000.00

$500,000.00

$400,000.00

$300,000.00

$200,000.00

$100,000.00

$0.00

0.08

0.08

0.08

0.08

0.08

$40,000.00

$32,000.00

$24,000.00

$16,000.00

$8,000.00

$37,037.04

$27,434.84

$19,051.97

$11,760.48

$5,444.67

Present = Period 0.

Capital employed = nondepreciated value of asset remaining. PV ot CCE = present value of the cost of capital employed.

Now in Table 5-9 we calculate the EVA. For purposes of this example, let's assume the project I earnings figure, before noncash additions, of $50,000 per year. That $50,000 is the earnings figi find the EVA, we simply make the risk adjustments by finding the present value of the EAT and s provides the PV EVA.

Table 5-9: EVA of Project

Present

1

2

3

4

5

Total

$50,000

$50,000

$50,000

$50,000

$50,000

$250,0

$46,296.30

$42,866.94

$39,691.61

$36,751.49

$34,029.16

$199,6

$0.00

$37,037.04

$27,434.84

$19,051.97

$11,760.48

$5,444.67

$100,7

$9,259.26

$15,432.10

$20,639.64

$24,991.01

$28,584.49

$98,9

0.08

0.08

0.08

0.08

0.08

PV of EAT = present value of earnings after tax.

PV of CCE = present value of the cost of capital employed.

PV of EVA = present value of economic value add.

We see in this example that the EVA is comfortably positive, so this project earns more than it c<

We see in this example that the EVA is comfortably positive, so this project earns more than it c<

Project Management Made Easy

Project Management Made Easy

What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.

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