Eva vs Roi

Why EVA is better than ROI (ROCE, ROIC,

RONA, ROA) and earnings, operating profit etc.

Equity investors should earn on their capital a return far over

risk-free interest rate in order to induce and maintain capital in

the company

Therefore earnings should always be judged against the capital

used to produce these earnings

Earnings can be easily increased simultaneously worsening the

position of shareholders e.g. if more capital is poured into a

company although the return on capital is 5% or less (even

lower than long-term government bond)

Thus it is clear for most people that any earnings figure can not

alone be a reliable performance measure (still some companies

use EPS !?)

!

Following slides focus on explaining why also return on

capital alone is often an unreliable performance measure

© Esa Mäkeläinen 12.3.1998

E-mail: Esa.Makelainen@iki.fi

1

EVA is a registered trademark of Stern Stewart & Co.

EVA vs. rate of return

There are two very good reasons why EVA is much better than

ROI (RONA, ROCE, ROIC) as a controlling tool and as a

performance measure

1. Steering failure in ROI

Increase in ROI is not necessarily good for shareholders i.e. maximizing

ROI can not be set as a target. (Increase in ROI would be unambiguously

good only in the companies where capital can be neither increased nor

decreased -> however we leave in a world where both operations are

easily executed in almost all companies)

2. EVA is more practical and understandable than ROI

As an absolute and income statement -based measure EVA is quite easily

explained to non-financial employees and furthermore the impacts of

different day-to-day actions can be easily turned into EVA-figures since

an additional $100 cost decreases EVA with $100. (ROI is neither easy to

explain to employees nor can day-to-day actions easily be expressed in

terms of ROI)

This latter benefit if often totally forgotten in academic discussion since it

can not, of course, be...