Coke vs Pepsi

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Date Submitted: 10/11/2014 08:16 PM

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Economic Value Added (EVA); Advantages and Disadvantages

The Economic Value Added (EVA) is a measure of surplus value created on an investment. It is closest in both theory and construct to the net present value of a project in capital budgeting. It is the difference between the firm’s after-tax return on capital and its cost of capital.

The basic concept of EVA is that performance should be measured in terms of the value added during the period. It is a measure of performance that is directly linked to shareholder wealth.

Advantages of EVA

1. EVA is closely related to NPV. It is closest in spirit to corporate finance theory that argues that the value of the firm will increase if you take positive NPV projects.

2. It avoids the problems associated with approaches that focus on percentage spreads - between ROE and Cost of Equity and ROC and Cost of Capital. These approaches may lead firms with high ROE and ROC to turn away good projects to avoid lowering their percentage spreads.

3. It makes top managers responsible for a measure that they have more control over - the return on capital and the cost of capital are affected by their decisions - rather than one that they feel they cannot control as well - the market price per share.

4. It is influenced by all of the decisions that managers have to make within a firm - the investment decisions and dividend decisions affect the return on capital (the dividend decisions affect it indirectly through the cash balance) and the financing decision affects the cost of capital.

Disadvantages of EVA

1. The calculation process requires numerous adjustments to profit and capital employed figures.

2. EVA does not facilitate comparisons between divisions since EVA is an absolute measure.

3. WACC calculation includes a huge number of assumptions.

4. EVA is based on historical data, which might not continue in the future.

Coca-Cola and Pepsi Co. EVA [1994-2000]...