Economic value added focuses on whether a project creates value above the opportunity cost of capital.

Economic value added focuses on whether a project creates value above the opportunity cost of capital.

• A. It is identical to net income
• B. It ignores capital costs
• C. It subtracts the cost of capital from NOPAT
• D. It measures after-tax profit

Answer: (C)

Economic value added is about creating value only when operating profits after tax exceed the opportunity cost of the capital used. In practice, EVA is calculated as NOPAT minus the capital charge, where the capital charge equals the cost of capital (often the weighted average cost of capital) times the amount of capital invested. This framing shows that value is added only if the project’s after-tax operating earnings cover the cost of financing it. So the best description is: EVA subtracts the cost of capital from NOPAT. If NOPAT exceeds the capital charge, EVA is positive, meaning value is created above the required return on capital. If not, EVA is negative. Net income is not the same as EVA because net income includes financing effects and non-operating items, whereas EVA uses NOPAT and explicitly deducts a capital charge. It does not ignore capital costs, since the whole point is to compare operating profits to the cost of financing. And while NOPAT is an after-tax figure, EVA is more than after-tax profit because it subtracts the capital charge to reflect the opportunity cost of invested capital.

Economic value added is about creating value only when operating profits after tax exceed the opportunity cost of the capital used. In practice, EVA is calculated as NOPAT minus the capital charge, where the capital charge equals the cost of capital (often the weighted average cost of capital) times the amount of capital invested. This framing shows that value is added only if the project’s after-tax operating earnings cover the cost of financing it.

So the best description is: EVA subtracts the cost of capital from NOPAT. If NOPAT exceeds the capital charge, EVA is positive, meaning value is created above the required return on capital. If not, EVA is negative.

Net income is not the same as EVA because net income includes financing effects and non-operating items, whereas EVA uses NOPAT and explicitly deducts a capital charge. It does not ignore capital costs, since the whole point is to compare operating profits to the cost of financing. And while NOPAT is an after-tax figure, EVA is more than after-tax profit because it subtracts the capital charge to reflect the opportunity cost of invested capital.