Economic value added

5 minutes 5 Questions

Economic Value Added (EVA) is a financial metric that assesses a company's ability to generate profit beyond its cost of capital, effectively measuring the true economic profit. In the context of a SHRM Certified Professional and the Metrics and Measurement of HR, EVA serves as a valuable tool to q…

Economic Value Added (EVA): A Comprehensive Guide

Introduction
Economic Value Added (EVA) is a financial performance metric that calculates the value a company generates from its invested capital.

Why is EVA Important
Understanding EVA helps organizations assess their true economic profit, guiding better decision-making and strategic planning. It aligns management's interests with shareholders by focusing on value creation.

What is EVA
EVA is defined as net operating profit after taxes (NOPAT) minus a charge for the opportunity cost of capital invested in the business. It represents the residual wealth after accounting for the cost of capital.

How EVA Works
EVA works by measuring a company's financial performance based on the residual wealth calculated after deducting the cost of capital. The formula is:
EVA = NOPAT - (Capital Invested × Weighted Average Cost of Capital)
This highlights whether the company is generating value above its cost of capital.

Calculating EVA
1. Determine NOPAT.
2. Calculate Capital Invested.
3. Find the Weighted Average Cost of Capital (WACC).
4. Multiply Capital Invested by WACC to get the capital charge.
5. Subtract the capital charge from NOPAT to obtain EVA.

Answering Exam Questions on EVA
When tackling exam questions on EVA, ensure you understand the components and the calculation process. Clearly define EVA, state the formula, and apply it correctly using given data.

Exam Tips: Answering Questions on Economic Value Added
• Understand the Formula: Be clear on the EVA formula and its components.
• Know the Concepts: Grasp the underlying concepts of NOPAT, WACC, and capital invested.
• Practice Calculations: Work through sample problems to become comfortable with the calculations.
• Show Your Work: Clearly outline each step when solving problems to gain partial credit if needed.
• Time Management: Allocate appropriate time to EVA questions to ensure completeness.

Test mode:

Exam (Timed)

Practice (With explanations)

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Question 1

As the HR Director, you are tasked with improving the company's Economic Value Added (EVA). Which of the following actions would most directly lead to an increase in EVA?

Expanding the benefits package to attract top talent in the industry. Reducing employee turnover to decrease recruitment and training costs. Implementing a new employee recognition program to boost morale and engagement. Launching a leadership development initiative to enhance managerial skills.

Correct Answer: Reducing employee turnover to decrease recruitment and training costs.

Reducing employee turnover to decrease recruitment and training costs is the best action to directly increase EVA. By lowering turnover rates, the company can reduce the expenses associated with hiring and training new employees, thereby improving net operating profit and EVA. Implementing a new employee recognition program can boost morale and engagement, which may indirectly contribute to performance but does not have as immediate an impact on costs. Launching a leadership development initiative enhances managerial skills, which can improve operations but is more of a long-term strategy. Expanding the benefits package might attract top talent, but it could also increase costs, potentially reducing EVA.

Question 2

In the context of Economic Value Added (EVA), what does the capital charge represent?

The total revenue required to sustain operations The cost of capital employed in the business The cumulative depreciation of physical assets The overall market value of the firm's equity

Correct Answer: The cost of capital employed in the business

The capital charge in the context of Economic Value Added (EVA) represents the cost of capital employed in the business. This is the minimum return that a company must earn on its invested capital to satisfy its investors. The other options relate to different financial aspects that do not specifically address the cost of capital within EVA.

Question 3

What component is essential in determining Economic Value Added (EVA)?

Operating income Capital expenditures Net profit margin Cost of capital

Correct Answer: Cost of capital

The cost of capital is essential in determining Economic Value Added (EVA) because EVA is calculated by subtracting the product of the cost of capital and invested capital from the net operating profit after taxes. This measure assesses whether a company is generating returns above its cost of capital. Operating income, net profit margin, and capital expenditures are important financial metrics, but they do not directly incorporate the cost of capital into the EVA calculation.

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