There are two main ways a company can improve its economic value added (EVA): to increase revenues or decrease expenditures on capital. Revenue can be increased by increasing the price or selling additional goods and services. Capital costs can be minimized in several ways, including increasing economies of scale. It is also possible for the company to offset capital costs, choosing investments that earn more than their respective costs of capital.
In the Eva formula, the revenue of the firm is expressed as equal to the net operating profit after taxes (NOPAT). The cost of capital is traditionally estimated using the weighted average cost of capital (wacc, or weighted average cost of capital$). Eva, also known as economic profit is the result of deducting all expenses, the net capital from NOPAT. This is one of the most popular profitability indicators used by companies and fundamental analysts.
If the company wants to improve its Eva by adding his income, he needs to ensure maximum profit is greater than the accompanying marginal costs, including taxes. It makes sense—you wouldn’t spend $150 to earn $100 of income. Since income is generally uncertain, it is often easier for the company to reduce its capex spending.
Net capital costs may be reduced by reducing operating costs, increasing marginal productivity, or both. The company can negotiate with your lender to get a lower interest rate on your debt or call on the preferred shares and to reissue them at lower interest rates.
Economic value added is sometimes also referred to as shareholder value Added (SVA), although some companies may make different adjustments to their NOPAT and the cost calculations of the capital. It’s not the same as value added the cash flow (cva) and that it is a measure used by value investors to see how well the company can generate cash flow.
(For associated reading, see: understanding economic value added.)