Economic Value Added Method of Valuation
What is the EVA Method of Business Valuation?
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Table of ContentsWhat is the Economic Value Added Valuation Method?Economic Value Added
What is the Economic Value Added Valuation Method?
This methodology focuses on the return on investment expected from the company above the relative cost of capital. Take the amount of requested or required investment. Determine the cost of obtaining that capital. That is, what will investors require as a return (dividend or capital appreciation) for that amount of investment. Then determine the amount of return that the company will generate in excess of this required cost of capital. The metric will determine if the company will produce returns that exceed the expectation of lenders or investors. The present value of these expected excess values is then added to the capital invested.
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Economic Value Added
The EVA method is sound in nature in that it values the firm based on the value of returns from invested capital above the firms average cost of capital. The difficulty with this approach is attributable to the early stage of the startup in the business lifecycle and the growth-based nature of the venture. The early stage of the business makes the estimation of revenue (or profits) difficult to project. The growth-based nature of the venture means that the firm will likely not return any profits to investors until a given date in the future. As such, the EVA approach is better suited to established firm that makes constant returns (such as dividends) to investors.