The Unbearable Lightness of EVA in Valuation
Duke University - Duke Center for International Development in the Sanford School of Public Policy
Fulbright Economics Teaching Program, HCMC, Vietnam
In the arena of valuation, the fanciful claims about the dethronement of the champion (a.k.a. NPV) by the concept of economic value added (EVA) have been greatly exaggerated, and it would be premature and unwise to abandon our reliable and trusted NPV. EVA is simply an interesting algebraic rearrangement of the standard cash flow model in terms of parameters from financial statements.
In this non-technical note, I use simple numerical examples to illustrate the games that people can play with EVA. There are two major flaws with EVA. First, in year n, the equity charge for calculating the residual income is based on the book equity value at the beginning of year n, and second, the residual income profile is dependent on the schedule for accounting depreciation. Consequently, it is problematic to interpret the meaning of the economic value added in any particular year, and furthermore, it is difficult to compare two different residual income profiles because the same cash flow stream can generate multiple profiles for the residual income.
The champion NPV is unfazed by the new arrival in the arena of valuation. In spite of all the hype in the media, the new arrival is simply an alter-ego.
Number of Pages in PDF File: 40
Keywords: Economic value added, residual income model, discounted cash flow
JEL Classification: D61, G31, H43working papers series
Date posted: May 15, 2001
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