VAIC: New Financial Performance Metric and Valuation Tool

Abstract

This article introduces a new financial metric for managerial performance evaluation, Value Added to Invested Capital (VAIC), with the cost of unlevered equity as a hurdle rate to calculate the capital charge rather than the widely accepted WACC. VAIC preserves all positive features of the conventional residual operating income and EVA® and has the distinct advantage of computational simplicity and straightforward interpretation. Associated valuation model is equivalent to the standard discounted cash flow approach; this equivalence is formally proved under certain assumptions regarding the risk of tax shields and confirms consistency of the new metric proposed. VAIC can serve as an aggregate financial indicator on the business performance dashboards, and might as well be considered a valid substitute for the established EVA© and ReOI metrics in evaluating managerial performance. Equivalence of the VAIC valuation model to the fundamental approach of valuing a business by cash flow discounting makes this metric not only a robust measure of financial performance but also a full-fledged investment valuation tool.

Keywords: Performance measurement, Economic Value Added, EVA, Residual income, Residual operating income, Valuation

JEL Classification: G32, G39, M21, M41