How is economic value added (EVA) calculated?

Economic Value Added (EVA) is a measure of a company's financial performance that reflects the residual wealth generated after deducting the cost of capital from its net operating profit after taxes (NOPAT). The correct way to calculate EVA is by taking the net operating profit after taxes and subtracting the product of the cost of capital and the invested capital. This captures the true economic profit of a company, emphasizing that value is created only when returns exceed the cost of capital.

In essence, the formula can be expressed as:

EVA = NOPAT - (Cost of Capital * Invested Capital)

This calculation provides insight into whether a company is creating or destroying value for its shareholders, as it accounts for the capital costs necessary to fund its operations. By focusing on the cost of capital, EVA aligns the interests of management with those of stakeholders, encouraging investments that generate returns greater than the cost incurred to obtain the capital.

The other answer choices either misstate the relevant deductions or fail to incorporate the concept of invested capital. For instance, calculating returns without considering the cost of capital directly leads to an incomplete assessment of economic performance. Therefore, understanding that EVA encompasses both NOPAT and capital costs is fundamental to grasping this important financial metric.