Decision Metric for Capital Budgeting: EVA vs DCF

Abstract

We compare the concept of Economic Value Added (EVA) with the traditional Discounted Cash Flows (DCF) method of investment appraisal. We find that DCF suffers from dynamic inconsistency and may approve suboptimal investment decisions. In contrast, EVA does not suffer from these shortcomings and is naturally suited to conduct an assessment in line with basic principles of dynamic decision-making. We discuss practical implications of our findings in the context of regulated industries.

Keywords: decision theory, economic profit, price regulation, valuation

JEL Classification: G11, G31, L43, L51