Saturday, May 23, 2009

Economic Value Added


EPS is calculated by dividing the net profits (after interest, depreciation and taxation) by the number of equity shares issued by the company to find out the profits earned per share. This measure is flawed because it does not consider the equity cost of capital employed (i.e. it assumes that equity capital comes to the company for free). EPS can be improved without corresponding improvement in performance simply by issuing further equity at a premium. Naturally, when more funds are pumped into the company, the size of the business increases without necessary increasing the profitability.


EVA takes into consideration the total capital employed by the company – total shareholders' fund (equity and accumulated profits) and total debt – and finds out the difference between the earning and the cost of the capital employed.

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