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Advances in Information Technology and Management (AITM) Vol. 2, No. 2, 2012, ISSN 2167-6372 Copyright © World Science Publisher, United States www.worldsciencepublisher.org 260 Efficacy of Economic Value Added Concept in Business Performance Measurement Sarbapriya Ray Shyampur Siddheswari Mahavidyalaya, University of Calcutta, India. Abstract: The idea of Economic Value Added (EVA) is somewhat new detection but the concept is age old. In contemporary economics and finance literature, EVA holds a less debated part as well as plays crucial role in business performance measurement. In corporate finance, Economic Value Added or EVA, a registered trademark of Stern Stewart & Co, is an estimate of a firm's economic profit – being the value created in excess of the required return of the company's investors (being shareholders and debt holders). This article tries to assess the efficacy of Economic Value Added concept in business performance measurement. This paper analyses the notion of Economic Value Added (EVA) that is gaining attractiveness in India and also examines whether EVA is a better business performance measure or not. EVA provides a basis for the measurement of efficiency and motivates managers to be more efficient with funds, which is usually beneficial. But, EVA is not contributing to the stock return because the investors’ reliance and belief is on the provision of dividends to the share holder rather than increasing worth of the business. However, this method must be cautiously applied to ensure that it is measuring economic effects appropriately and does not create time-horizon distortion. Keywords: Residual Income (RI), Shareholders’ Value, Market Value Added, economic value added, wealth maximization. 1. Introduction In contemporary economics and finance literature, EVA holds a less debated part as well as plays crucial role in business performance measurement. In corporate finance, Economic Value Added or EVA, a registered trademark of Stern Stewart & Co, is an estimate of a firm's economic profit – being the value created in excess of the required return of the company's investors (being shareholders and debt holders). It is the performance measure most straightforwardly connected to the creation of shareholders wealth over time. The very logic of using EVA is to maximize the value for the shareholders. Economic Value Added (EVA) analysis measures how profitable it truly is to run a business instead of selling it.The objective of every business entity should be to maximize shareholders wealth by enhancing the firm’s value and all the activities of a firm should be directed to achieve this objective. In order to materialize this objective, shareholder wealth is conventionally substituted by either standard accounting magnitudes (such as profits, earnings and cash flows from operations) or financial statement ratios (including earnings per share and the returns on assets, investment and equity). This financial statement information is then used by managers, shareholders and other interested parties to assess current firm performance, and is also used by these same stakeholders to predict future performance. Business performance is divulged in the maximization of market value of own capital. The research findings in developed countries reflect that the correlation between the stated accounting net profit and stock market movement derived from it is not physically powerful enough. Therefore, a new model of measuring business performance-namely economic value added (EVA) has been emerged in addition to traditional accounting measures of business performance. The EVA model in addition to costs of borrowed capital also brings into consideration own capital costs, which depend on alternative investments made by investors who bear the same risk. EVA is the difference between net profit after tax (NOPAT) and the required return on the financing of own and others' capital. This way EVA offers a fundamental role to the drop or increase in value of own capital. Positive EVA in a given period indicates that the management increased the value for owners, and negative EVA implies that there is a decrease of the value for owners. In view of the above discussion, this article tries to assess the efficacy of Economic Value Added concept in business performance measurement. 2. Evolution of EVA The idea of Economic Value Added (EVA) is somewhat new detection but the concept is age old. EVA is Sarbapriya Ray, AITM, Vol. 2, No. 2, pp. 260-267, 2012 fundamentally indistinguishable to the idea of residual income (net income minus a charge for the cost of equity capital) developed by economists such as Alfred Marshall in the 1890s. Marshall defined economic profit as total net gains less the interest on invested capital at the current rate. The Marshallian focus of analysis has been on adjustments to accounting earnings to reflect the opportunity cost of capital, primarily because the unadjusted measure can be a misleading indicator of performance in both theory and practice.In his seminal book ‘Principles of Economics’, Marshall (1920) is of the notion that: “the gross earnings of management which a man is getting can only be found after making up a careful account of the true profits of his business, and deducting interest on his capital”. Afterward, the David Solomon (1965) quantified ‘economic profit’ as a measure of wealth creation “as the difference between two quantities, net earnings and the cost of capital”. This measure of ‘residual income’ is then defined in terms of after-tax operating profits less a charge for invested capital which reflects the firm’s weighted average cost of capital. Close parallels are thereby found in the related (nontrademarked) concepts of ‘abnormal earnings’, ‘excess earnings’, ‘excess income’, ‘excess realizable profits’ and ‘super profits’ (Biddle et al., 1997). As Peter Drucker puts it in his Harvard Business Review (1998, p. 14) article: EVA is based upon something we have known for a long time: What we call profits, the money left to service equity, is usually not profit at all. Until a business returns a profit that is greater than its cost of capital, it operates at a loss. Never mind that it pays taxes as if it had a genuine profit. The enterprise still returns less to the economy than it devours in resources… Until then it does not create wealth; it destroys it. Dodd & Chen (1996, p. 27) opined that the idea of residual income appeared first in accounting theory literature early in twentieth century by e.g. Church in 1917 and by Scovell in 1924 and appeared in management accounting literature in the 1960s. The origins of the value added concepts date all the way back to the early 1900's (Bromwich & Walker, 1998, p. 392). General Motors put into practice a residual income measure for performance evaluation and compensation in the 1920s [S. David Young, 1999]. Over the last two decades, a number of factors (deregulation and integration of capital markets, more liquid securities markets, expansion of institutional investment, advances in information technology) have considerably increased the mobility of capital, forcing firms to compete not only in product markets but also in capital markets, where returning the cost of capital—the return expected by investors—is a key success factor. At the same time, finance theory has evolved making the estimation of a cost of equity a more accessible task. Also Finnish academics and financial press discussed the concept as early as in the 1970s. It was defined as a good way to complement ROI-control (Virtanen, 1975, p.111). In the 1970s or earlier residual income did not got wide publicity and it did not end up to be the prime performance measure in great deal of companies. However EVA, practically the same concept with a different name, has done it in the 261 recent years. Stern Stewart & Co trademarks EVA in 1990’s when the tool is introduced and subsequently adopted by several major corporations that lead EVA to have successful stories at the very beginning. With the successive developments and the growing demand for new “value-based” management practices that could better line up the interests of managers with those of shareholders, the consulting firm Stern Stewart & Company, in the 1980s and 1990s, invigorated the notion of residual income. Stern Stewart developed this notion into a broader, EVA-based management control system, implemented at dozens of large, publicly traded companies including AT&T, CocaCola, and Quaker Oats. O'Hanlon & Peasnell (1998) thoroughly discuss EVA as a value-based performance indicator, Stern Stewart Co intricate adjustments, EVA benchmarks, and EVA-based bonuses. Bromwich & Walker (1998) add to the theoretical discussion by pondering the EVA debate all the way from Hicksian income concepts. 3. Economic Value Added (EVA) Meaning of EVA is nothing but a new version of the age-old residual income concept recognized by economists since the 1770's. Both EVA and ‘residual income’ concepts are based on the principle that a firm creates wealth for its owners only if it generates surplus over the cost of the total invested capital. Despite the relatively recent adoption of EVA as an internal and external financial performance measure, its conceptual underpinnings derive from a wellestablished microeconomic literature regarding the link between firm earnings and wealth creation (Bell, 1998). EVA, or Economic Value Added, is such a metric that seeks to improve and measure efficiency and “value creation” (Shaked & Leroy, 1997, p. 1; Stewart, p. 3).‘Economic Value Added’ (EVA) is a trademark of the Stern Stewart consulting organization. Stern Stewart maintains that the implementation of a complete EVAbased financial management and incentive compensation system gives managers both better information and superior motivation to make decisions that will create the greatest shareholder wealth in any publicly-owned or private organisation. Stewart defines EVA to be “the difference between the profits each unit derives from its operations (NOPAT) and the charge for capital each unit incurs through the use of its credit line” (Stewart, 1991,p. 224 ).Economic value added as an innovative approach to the measurement of business performance gives us a more realistic overview about the current state of the company. Taking into account the cost of equity and the possibility of execution of numerous accounting modifications represent significant innovations regarding to other concepts. EVA is the amount of economic value added for the owners by management. The thrust area for today’s management is to find means to create value for the owners. It is now established that the accounting profit in no cases represents the real value created for the owners. But, it may originate the calculation. In other words, accounting profit is required Sarbapriya Ray, AITM, Vol. 2, No. 2, pp. 260-267, 2012 to be converted into economic profit. Under EVA, all distortions in conventional accounting are identified and accounting profit is adjusted to make it distortion free and finally we get the amount of EVA. Peter Drucker has suggested in a Harvard Business Review article that ‘until a business returns a profit that is greater than its cost of capital, it operates at a loss’. This is in spite of the fact that it still pays tax as if it had a genuine profit. Drucker observes that such organizations return less to the economy than they consume in resources, and that instead of ‘creating’ they are in fact destroying wealth. EVA explicitly recognizes that when managers employ capital they must pay for it in the same way that they would pay other operating expenses. By taking all capital costs into account, including the cost of equity, EVA shows the amount of wealth a business has created or destroyed in each reporting period. In other words, EVA represents profit the way shareholders define it. Economic value added is the difference between net operating profit after taxes (NOPAT) and cost of capital. It can be calculated using the following formula (Stewart, 1991, pp. 136-137): EVA = NOPAT - WACC% * IC, whereas: EVA = Economic value added; NOPAT = Net operating profit after tax, WACC% = weighted average cost of capital; IC = Total business capital invested. Stewart defined EVA (1990, p.137) as Net operating profit after taxes (NOPAT) subtracted with a capital charge. Algebraically, it can be stated as follows: EVA= NOPAT- Capital Costs →NOP (1-T)- Capital Employed × Cost of Capital →Adjusted NOP (1-T)- Capital Employed ×WACC →Adjusted NOP (1-T)- [Capital Employed ×{(R e ×E/CE)+( R d ×D/ CE) (1-T) + ------}] →Return- Capital Employed×WACC →(Rate of ROI- WACC) ×Capital Employed -------------(1) NOPAT: Net operating profit after taxes (NOPAT) is simply a fully taxed version of operating profits (Earnings Before Interest and Taxes, EBIT). It is worth noting that interest payments are not deducted prior to calculating NOPAT. The cost of debt financing and the value of the resulting interest-tax shields are reflected in the after-tax cost of debt. Cost of Capital: The weighted average cost of capital (WACC) measures the composite return expected by all of the firm’s investors. The specific returns expected by debt and equity holders are estimated using the Capital Asset Pricing Model (CAPM), while the weights of debt and equity should be based on their market values. Capital Employed: The amount of capital employed can be calculated in two equivalent ways. One approach focuses on the right side of the balance sheet and defines invested capital as the sum of shareholders’ equity and any interest- 262 bearing debt (long-term debt, short-term debt, other longterm liabilities). This method, also known as the financing approach, is a direct expression of the net funds that investors have committed to the firm. The other approach focuses on the left side of the balance sheet and defines invested capital as the difference between total assets and short-term, non-interest bearing liabilities—known as the operating approach. In assessing EVA, one should recognize that it is an annual measure of performance with a historic perspective. The use of EVA represents an attempt to measure whether the management of an entity has used available funds in order to ‘create’ or ‘destroy’ value. Typical adjustments that are required in EVA calculations include Adjustment to net profit Add: net capitalised intangibles Add: goodwill written off and accounting depreciation (deduct cumulative depreciation previously economic depreciation) Add: increases in provisions such as those in respect of bad debts and deferred tax . Capital being used in EVA calculation is not the book capital, capital is defined as an approximation of the economic book value of all cash invested in going-concern business activities, capital is essentially a company’s net assets (total assets less non-interest bearing current liabilities), but with following adjustments: Adjustment to capital employed Subtract marketable securities and construction in progress Add: net book value of intangibles Add :present value of noncapitalized leases to net property, plant, and equipment. and Add cumulative goodwill written off Add :provisions such those in respect Add :R&D expense that is capitalized as a long-term asset Add: back interest on debt capital Add: debt to net assets such that it forms part of capital employed Add: Cumulative unusual losses (gains) after taxes that are considered to be a long-term investment. The purposes of such adjustments are to quantify capital at nearer to the current value, to embrace all investments that are treated as period costs by accountants (such as R&D expenditure) and to get EVA closer to the real cash flows of the company. These adjustments are done to depict an EVA figure nearer to cash flows, and less subject to the distortions of accrual accounting. It eliminates the arbitrary distinction between investments in tangible assets, which are capitalized, and intangible assets, which tend to be written off as incurred and avert the amortization, or writeoff, of goodwill, convey off-balance sheet debt into the Sarbapriya Ray, AITM, Vol. 2, No. 2, pp. 260-267, 2012 balance sheet and tries to rectify biases caused by accounting depreciation. ( S David Young,1999). The arguments for adjustments are depicted below: (i).Only the costs of successful investments (those with future economic significance) are capitalised and placed on the balance sheet. Unsuccessful investments are conventionally written off. EVA proponents say that the unsuccessful investments are just as important to shareholders as successful investments and should go on the balance sheet and the loss will be recognized gradually in future periods in the form of higher capital charges, and thus lower EVA. (ii). Proponents of EVA recommend R&D to be capitalized. The logical ground put forth by them is that manager of a company that does not capitalize R&D might be tempted to under-investment because short-term profits will be adversely affected by R&D expenditures whereas the benefits will not be realized until future periods (Young, 1999, p. 11). To capitalize R&D, the adjustment is to add back R&D costs to NOPAT and shareholders’ equity. The capitalised costs are then written off gradually, with an amortization period based on the number of future periods expected to benefit from whatever products or services are developed from the R&D (Young, 1999, p.10). It has been observed that once a steady state is reached, operating income is not affected by the R&D adjustment a firm that capitalizes R&D as compared to the firm that follows conventional accounting. However, the EVA figure is lower in the firm that capitalised R&D, and this more accurately reflects the higher capital charges. (iii). Deferred tax assets arise when provisions are made for future costs that serve to reduce current book income. These may include provisions for warranties, restructuring and environmental clean up. The net change of EVA is to add (or subtract) these changes in deferred tax to more accurately reflect the actual cash flows to tax authorities. In other words, the “deferred tax adjustment brings EVA closer to cash flows, and thus eliminates any influence on profits from one of the most important components of accrual accounting” (Young, 1999, p. 12). (iv). Intangibles (especially goodwill arising from corporate acquisitions) are not automatically written off in an EVA system. The argument is that the write-off of goodwill (whether at acquisition or more gradually through capitalization and amortization) effectively removes at least part of the acquirer’s investment in the target from the balance sheet, “…thereby lessening management’s burden to earn a competitive return on that portion of invested capital” (Young, 1999, 12). (v). EVA proponents argue that EVA should be constant over the life of the asset, and should be depreciated in exactly the same way that bank loans are amortized (Young, 1999, p. 14). 263 (vi). Restructuring changes that involve cash payments are considered capital under EVA. The argument is that such adjustments should only be made to generate returns in a later period, and therefore should also provide an appropriate return. The crucial point of departure for EVA from RI is the adjusting of both NOPAT and CAP for supposed ‘distortions’ in the accounting model of performance. EVAtype adjustments are made to both accounting measures of operating profits (NOPAT), and accounting measures of capital (CAP). EVA thereby reflects adjustments to GAAP in terms of both operating and financing activities. Therefore, net operating profit is adjusted for accounting distortions and a charge on capital employed at the rate of weighted average cost of capital (WACC) is subtracted from NOPAT to reach to the amount of EVA. The EVA equation suggests that earning a return greater than the cost of capital increases value for the owners and vice versa. Stewart defined an alternative measure that evaluates whether a company has created shareholders’ wealth. If the total market value of a company exceeds the amount of capital invested in it, the company has managed to create shareholder value. If reverse is the case, i.e., the market value is less than the amount of capital invested, the company has ruined shareholder value. Stewart (1990, p.153) calls it as Market Value Added (MVA) and can be equated as follows: MVA= Market Value of the Company- Capital Invested → Market Value of Equity-Book Value of Equity (It has been assumed that capital invested is Book Value of Equity) →( Market Value of Equity-Book Value of Equity) ×No of shares outstanding →Present value of all future EVA------------ (2) In other words, Market Value of Equity= Book Value of Equity+ Present value of all future EVA----- (3) Positive MVA indicates that market-to-book ratio is more than one. Negative MVA, on the other hand, signifies market-to-book ratio less than one. If a company’s rate of return exceeds its cost of capital, the company will sell on the stock markets with premium compared to the original capital. On the other hand, companies that have rate of return smaller than their cost of capital sell with discount compared to the original capital invested in company. The main distinguishing feature of MVA is that it is largely a cumulative measure and therefore communicates the market’s present verdicts on the net present value (NPV) of all the firms’ past, current and contemplated capital investment projects (O’Byrne, 1996, p. 199). However, in contrast to MVA, EVA is a measure that focuses on firm performance over a specific period. It therefore has a similar time perspective to the second set of firm Sarbapriya Ray, AITM, Vol. 2, No. 2, pp. 260-267, 2012 performance measures; namely, earnings before extraordinary items (EBEI), net cash flow from operations (NCF) and residual income (RI). The appeal of EVA lies in its intuitive interpretation. A positive EVA suggests that the firm has generated profits in excess of the amount required to remunerate investors (at market rates) for the capital they have provided. In short, the firm has paid its operating and capital costs and created additional wealth. Negative EVA, instead, suggests that the firm “devours resources” (in Peter Drucker’s terms) without providing a commensurate return for their use. 4. Role of EVA in business performance measurement Stern Stewart argues that EVA is the financial performance measure that arrests the true economic profit of an organization, and is the performance measure most directly linked to the creation of shareholder wealth over time. EVA is an estimate of the amount by which earnings exceed or fall short of the required minimum rate of return that shareholder and debt holder could get by investing in other securities of comparable risk. Stern et al (ed 2001) suggest that ‘when fully implemented’ EVA will be ‘the centerpiece of an integrated financial management system that incorporates the full range of corporate financial decision making’. Under conventional accounting, most companies seem profitable but many in fact are not. Company may intentionally pay tax to prove that they have made profit for their shareholders and thus a falsification is done with owners that is not a rare corporate practice. EVA corrects this error by explicitly recognizing that when managers employ capital, they must pay for it, as if it were a wage. It also adjusts all distortions that are very much prevalent in the information generated by conventional accounting. Thus, it is the most demanded tool for the owners in every situation. Proponents of EVA argue that EVA is a superior measure as compared to other performance measures on the grounds that i) it is nearer to the real cash flows of the business entity;(ii) it is uncomplicated to calculate and understand;(iii) it has a higher correlation to the market value of the firm and its application to employee compensation leads to the alignment of managerial interests with those of the shareholders, thus minimizing the supposedly dysfunctional behavior of the management. EVA might also be suitable to uniting the interests of the management/owners and ordinary employees. According to professors Michael J. Jensen from Harvard Business School and Kevin J. Murphy from University of Chicago, the biggest problem with top management salaries is that managers are currently paid like bureaucrats rather than like value maximizing entrepreneurs (Jensen & Murphy 1990, p.1). They also affirm that traditional bonus systems produce far too small incentives for good performers and guarantee too big compensation for mediocre performers (1990, p.3). EVA can also be used in Group-level controlling of operations. EVA may also 264 ensure optimum capital structure by making the firm properly levered. The capital charge is the most distinctive and important aspect of EVA. Under conventional accounting, most organizations appear profitable, but many, in fact, are not creating value. By taking all capital costs into account, including the cost of equity, EVA shows the amount of wealth a business has created or destroyed in each reporting period. In other words, EVA represents profit the way shareholders define it. Stern et al (2001) argue that the development of EVA coincides with the increased ‘empowerment’ of managers as decision makers, and is a tool to meet the potential agency issues that are created when ownership and management are separated. Stern et al argue that a sustained increase in EVA will precipitate an increase in the market value of an organization and suggest that the adoption of an EVA approach has proved effective in virtually all types of organisation, from emerging growth companies to those organisations involved in ‘turnaround’ situations that bring continuous increases in shareholder wealth. Compensation methods based on EVA facilitates in achieving the objective of goal congruence and minimizes the agency cost. Use of EVA improves ‘internal corporate governance’ in the logic that it motivates manager to get rid of value destructive activities and to invest only in those projects that are expected to enhance shareholder value. EVA measures for incentive compensation leads to the improvement in operating efficiency by increasing asset turnover.Though EVA fails to provide additional information to the capital market, it can be used to improve the internal governance of a firm.Preferably, a management control system should stimulate managers for ‘self control’ rather than managers are being controlled because human beings have general resistance to controls. Linking compensation with EVA assists employees in conducting a self-examination of every action taken by them to ensure that it enhances EVA of the firm. Another advantage of EVA is that its applicability is practically universal. Its simplest application requires only two of the most commonly used financial statements; the balance sheet and the income statement, allowing it to be applied to virtually any company with accurate financial statements (Mäkeläinen & Roztocki, p.5 ).The fact that the principles of EVA (efficiency, increasing wealth) can be easily conveyed to others, including employees, gives them a common goal that they can clearly contribute to and appreciate (Mäkeläinen & Roztocki, p. 6).While the theory underlying EVA and its application can be complex, the basic points it stands for appeal to common sense. EVA can also be used as a kind of diagnostic tool, showing managers which sections of the firm need more work to increase a firm’s value for the next period (Mäkeläinen & Roztocki, p. 18 ). In a nut shell,EVA has the advantage of being conceptually simple and easy to explain to non-financial managers, since it starts with familiar operating profits and simply deducts a charge for the capital invested either in the Sarbapriya Ray, AITM, Vol. 2, No. 2, pp. 260-267, 2012 company as a whole, or in a business unit, or even in a single plant, office, or assembly line. EVA can be used as an effective performance measure because of its ability to measure results periodically. Advocates of EVA affirm that its use provides a superior measure of the year-to-year value that the business creates. Moreover, because EVA measures performance in terms of ‘value’, it should be the basis of any financial management system used to set corporate strategy, or to evaluate potential capital investment decisions, corporate acquisitions, or performance. 5. Flip side of EVA The computation of economic value added emerges straightforward at sudden look; nevertheless, in practice there is a whole range of issues. Consequently, the idea of EVA is simple and theoretically well-designed, but its implementation is difficult and often takes away much of the potential benefits. If the accounting values were based on cash flows, economic value added would more accurately reflect the economic performances of a company. In addition, the selection of adaptation methods is largely marked by subjectivity. The next great problem is associated with the calculation of the cost of capital. Financial theory offers a variety of methods, each of them having their advantages and disadvantages. Although, in most cases the calculation of the cost of capital is based on the use of the CAPM model, which was argued to be inadequate for the less developed capital markets. Similarly it is complicated to use CAPM in measuring cost of equity because of the difficulty in measuring risk-free-rate of return, beta and market premium. Difficulties get multipled in an economic environment like India, where interest rates fluctuate recurrently, the capital market is volatile and the regulators are yet to have a complete hold on the capital market to improve its efficiency.Empirical studies show that the volatility in the Indian capital markets, like capital markets in other developing economies, is higher than capital markets in developed economies (Tushar Waghmare 2000). In the same way, reseach analyses show that beta for companies listed in Indian capital markets is not stable (Sanyal, Guha Roy and Sanyal 2000). It is difficult to determine the market premium because of the short history of the Indian capital market and also because of its high volatility. Consequently, it can be concluded that the potential of EVA as a measure of performance can be realized fully in an advanced economy, the argument that EVA is a better measure is not justifiable in the Indian context. (i). The calculation of EVA can be intricate when many adjustments are required. EVA is difficult to use for interfirm and inter-divisional comparisons because it is an absolute rather than a relative measure. Allowance should be made for size when inter-company comparisons are made 265 (ii). A major disadvantage of EVA is the difficulty to accept the notion of the universal suitability of EVA. Some suggest that EVA is not the best choice for all companies. These experts believe that EVA is more suited to established companies “with few requirements for Economic Value Added capital expenditures” likely because capital is a major factor in the EVA equation. (iii). Since EVA is assessed to be a short-term performance measure, it is not possible for many corporate houses to adopt EVA in practice because of their focus on long-term investments. Moreover, the result on the basis of EVA could be manipulated by early yield projects over longerterm, delayed income stream, higher yield projects. Management might also limit its investment cash flows, such as research and development or advertising costs, to the long-term detriment of the business. (iv). The inflationary factor may limit periodic EVA to estimate the value added to shareholders properly. (v). EVA is a short-run notion dealing only with the current reporting period, whereas managerial performance measures should focus on the future results anticipated as a consequence of present managerial actions. Divisional performance should be appraised on the basis of economic income by estimating future cash flows and discounting them to their present value. This calculation could be made for a division at the beginning and end of a measurement period. The difference between the beginning and ending values would represent the estimate of economic income. However, the main problem associated with the use of estimates of economic income to evaluate performance is that it lacks precision and objectivity. The true return or true EVA of long-term investments cannot be measured objectively because future returns cannot be measured; they can only be subjectively estimated. (vi). The use of conventional depreciation methods is indicative of the fact that there is no assurance that the measurement of EVA in the short-term will be in conformity with the measurement of EVA in the longerterm. Moreover, a company may have a lot of undepreciated new assets in its balance sheet and it might show negative EVA even if the business would be quite profitable in the long run. Economic depreciation is difficult to estimate and conflicts with generally accepted accounting principles, which may hinder its acceptance by financial managers. (vii). EVA is possibly not an appropriate key performance measure for companies that have invested greatly at present and expect positive cash flow only in a distant future. 6. Summary & Conclusion Economic value added has become the most fashionable measurement for determining the ability of a company to Sarbapriya Ray, AITM, Vol. 2, No. 2, pp. 260-267, 2012 generate an appropriate rate of return. Despite the relatively recent adoption of EVA as an internal and external financial performance measure, its conceptual underpinnings derive from a well established micro economic literature regarding the link between firm earnings and wealth creation.EVA metrics provide managers with a commanding tool to weigh investment and spending decisions against capital requirements and investors’ expectations. The perception of EVA is based on the effective economic principle that firm’s value increases only if it is able to generate surplus over its cost of capital and therefore it is based on well-built theoretical foundation. It can also be linked to a company’s compensation system, so that managers are paid (or not) based on their ability to combine efficient asset utilization with profitable operating results. Admittedly, EVA is one of the ways to evaluate the usefulness of a performance measure. EVA identifies not only end results, but also the cost of the input of funds to get the results. This provides a basis for the measurement of efficiency and motivates managers to be more efficient with funds, which is usually beneficial. But, EVA is not contributing to the stock return because the investors’ reliance and belief is on the provision of dividends to the share holder rather than increasing worth of the business. 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