Disadvantages Of EVA

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One of the key differences of EVA is that it takes into account all the costs of doing business: actual (explicit) and alternative (implicit) costs. Thus, it allows investors to compare the profitability, earned by capital of the company with the opportunity cost of investing their funds. Knowing all costs makes it possible to correctly estimate the fundamental value of the company whose growth is actually a main goal of any corporate strategy. The mechanisms to reward executives of the company as well as individual managers responsible for each department are built on the basis of EVA performance measurement. There is a direct correlation between getting benefits and risk in the system. This correlation has no upper or lower limits, which…show more content…
To put it simply, it is when its operating income exceeds the cost of capital employed. EVA = Net Operating Profit After Tax – Capital Charge Where, Capital Charge = Cost of Capital * Net Operating Assets It is stated that one of the main advantages of EVA over other performance measures is its ease of use and intuitive interpretation. Positive EVA means firm or its division (depending on what is being measured) is doing good as it generates excess profit that exceeds investors’ expectations. Negative EVA means company or a division just “eats” money and not justifying use of capital and associated expenses. EVA as a “win-win” method of performance measure for both shareholders and managers as managers basically are remunerated for increasing shareholders value. EVA as remuneration tool helps to avoid agent-principal issues and aligns interests of both shareholders and manager. It also provides managers with incentives, limits retention risk and limits shareholder costs associated with the compensation plan. Also, EVA helps to prevent short-termism in managers’ performance. However, there are some
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