Q. Explain Economic value added?

Economic value added was developed by Stern Stewart & Co and is a registered trademark. EVA is an estimate of economic profit, measured as Net Operating Profit after Taxes (or NOPAT) less the money cost of capital.  MVA and EVA are strongly correlated; EVA is an internal management measure of performance that ultimately leads to satisfying MVA, an external measure used by shareholders or other investors.

economic value created by a division in a given period of time'

EVA =

Net cash operating profit after tax

('Adjusted' for accounting distortions e.g. add back depreciation)

Less

Economic depreciation (based on market value or replacement cost of assets)

Less

Amortised R&D, advertising, marketing, goodwill, brand or new product development cost

Less

('adjusted' capital employed x cost of capital)

EVA is a similar measure to residual income but uses cash based, economic or relevant costing methods, it is not based on accounting convention like residual income. EVA uses the economic replacement cost of non-current assets and working capital when applying a cost of capital for  the calculation of  'financing' to be recognised, the net assets of the division adjusted from historical accounting  terms  to current or  'replacement' cost when doing so.  Depreciation in EVA terms would be calculated using the replacement cost of non-current assets, accounting depreciation being added back and economic depreciation being deducted instead.  

EVA principles recognise also that long-term expenditure which adds and builds value for the future should be capitalised with the replacement cost of other non-current assets and the expenditure amortised over its useful economic life.  For expenditure on R&D, marketing, new product development etc., accounting convention would normally write off such expenditure in the financial period when it is incurred, EVA would capitalise it and amortise it, the amortisation each year deducted as an expense when arriving at EVA.