Economic Value Added

Based upon the above meaning of economic profit- Stern Stewart & Co. recognised that management’s goal should be to maximise the market value of company but also that this could not be done in isolation from the capital invested in the company. Thus, management should aim to maximise the difference between the market value and the invested capital (debt + equity); this is known as market value added or MVA. However, higher MVA is the result of management action and not a tool in itself. SIMILAR TO DCF where the decisions are done to improve FCF, managers take projects with positive NPV. BUT what was needed was a tool that management could use to assess whether a particular action should, or should not, be taken. Stern Stewart saw EVA as the appropriate tool. EVA = (return on invested capital - cost of capital) × invested capital.

Unlike net present value (NPV) calculations, EVA™ can be used as an effective performance measure because of its ability to measure results periodically. Proponents of EVA™ assert that its use provides a superior measure of the year‑to‑year value that the business creates. Moreover, because EVA measures performance in terms of ‘value’

Both models are used to measure value creation of companies and frequently applied in company’s valuation and investment project valuation each investment is evaluated of future decisions over its useful life based on the expected cash flows. The result is net present value (NPV) and a positive NPV show that investment creates value.

It is a notion that EVA approach requires less information than a DCF valuation, or that it provides a better estimate of value is false. The EVA approach should yield the same value as a DCF valuation (DAMODARAN), and it requires more information, not less (forecast of capital spend on assets, investments and acquisitions). The DCF valuation requires cash flows and a discount rate to arrive at a value, whereas the EVA approach requires these inputs