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Date Submitted: 10/12/2015 06:04 PM
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...