What does Economic Value Added (EVA) measure?

Economic Value Added (EVA) is a financial metric that measures a company’s financial performance and is designed to capture the true economic profit of an organization. It calculates the residual income generated after deducting the cost of all capital employed in generating that income. This approach emphasizes not just profit generation, but the efficiency of capital use as well.

By focusing on profits remaining after deducting the cost of capital, EVA provides a clearer picture of whether a company is truly creating value for its shareholders. This aligns with the objective of measuring a firm’s ability to generate wealth in excess of its cost of financing its operations, whether through debt or equity.

The other options do not fully encapsulate the essence of EVA. For instance, measuring profit before taxes and interest does not account for the cost of capital, leading to potentially misleading interpretations of profitability. Similarly, simply looking at overall revenues generated does not factor in costs associated with generating those revenues, nor does it reflect the economic realities of capital investment. Lastly, a rate of return on equity investments only provides a narrow perspective and ignores the broader impact of capital costs and how they influence overall economic profit. Thus, focusing on profits after capital costs is critical to understanding a company's generation of value.