Economic Value Added (EVA)

An estimate of a business’ true economic profit for the year, differing sharply from accounting profit. EVA represents the residual income that remains after the cost of all capital, including equity capital has been deducted, whereas accounting profit is determined without imposing a charge for equity capital.
The basic formula for EVA is as follows:
EVA = Net Operating Profit After Taxes (or NOPAT) – After-Tax Dollar Cost of Capital Used to Support Operations = EBIT (1-Corporate Tax Rate) – (Operating Capital)*(After-Tax Percentage Cost of Capital)
Equity capital has a cost, because funds provided by shareholders could have been invested elsewhere where they would have earned a return. Shareholders give up the opportunity to invest funds elsewhere when they provide capital to the firm. The return they could earn elsewhere in investments of equal risk represents the cost of equity capital. This cost is an opportunity cost rather than an accounting cost.
It is important to note that when calculating EVA we do not add back depreciation. Although it is not a cash expense, deprecation is a cost, and it is therefore deducted when determining both net income and EVA.