EVA Performance Measurement is Faulty: So You May Be Persuaded to Switch to a Robust OEVA-TEVA Alternative
26 Pages Posted: 17 Feb 2013
Date Written: February 16, 2013
We argue that the Economic Value Added (EVA) is biased by design and will generally yield distorted assessment of both the operating and overall performance. Fundamentally, the scale of measurement bias depends on the interest tax shield actually obtained in a measurement period and on a book to value ratio, however, there are also other potentially significant sources of distortions induced by the metric design. A robust alternative we propose is a concurrent evaluation of operating and total performance with the two nested metrics, Operating EVA (OEVA) and Total EVA (TEVA). OEVA applies the risk of assets (rather than WACC) to calculates the full capital charge and is unaffected by financing activities. TEVA incorporates financing side effects by explicitly adding interest tax shields to OEVA, but can be calculated as simply as a sum of interest expenses and net income less the full capital charge. The OEVA-TEVA approach is computationally simpler than EVA, the corresponding valuation model is consistent with the cash flow discounting and can be utilized as a self-sufficient instrument for investment project appraisal and business valuation.
Keywords: Financial performance measurement, economic value added, operating EVA, total EVA, residual income, valuation model, market value added
JEL Classification: G32, G39, M21, M41
Suggested Citation: Suggested Citation