Sharpening Performance Measurement with the Operating and Total EVA
21 Pages Posted: 8 Jun 2016
Date Written: march 18, 2013
Taking a slightly closer look at the EVA basics prompts that the metric by design is a synthetic mixture of returns from the operating and financing activities, and therefore, yields a biased assessment of both the operating and overall performance. Fundamentally, the scale of the measurement bias depends on the interest tax shield actually obtained in a measurement period and on the book to value ratio, however, there are also other potentially significant sources of distortions induced by the metric design.
An effective way to calibrate measurements is to evaluate the operating and total performance concurrently with the two metrics, the Operating EVA and the Total EVA. Operating EVA is calculated by applying the risk of assets rather than WACC to calculate the capital charge and unaffected by the financing side effects of the firm’s activities. It is unbiased and provides an informative estimate of the efficiency in ongoing operations and a basis for the overall performance assessment with the Total EVA. Both metrics are straightforward for interpretation and computationally simple relative to EVA. From the corporate finance perspective, the proposed dual-metric financial model is consistent with the fundamental approach of valuing a firm by cash flow discounting.
Keywords: Financial performance measurement, economic value added, market value added, valuation, operating EVA, total EVA
JEL Classification: G32, G39, M21, M41
Suggested Citation: Suggested Citation