The Relationship Between Economic Value Added, Net Present Value and True Return

J U de Villiers

Studies in Economics and Econometrics, 2005, vol. 29, issue 3, 81-109

Abstract: This paper investigates the relationship between economic value added (EVA) and the net present value (NPV) of projects, and especially the extent to which this is influenced by arbitrary depreciation schedules. For any depreciation schedule, the discounted EVA of a project is identical to its NPV. In project evaluation, EVA therefore overcomes the differences between earnings and cash flow introduced by arbitrary depreciation schedules. The paper also investigates the relationship between the true return of a project or a firm and the EVA reported by a project once in operation or the EVA reported by a firm. In these applications, the distortions caused by arbitrary depreciation schedules remain. Standardised EVA equals the true excess return for a firm that charges economic depreciation, or for a firm that grows at its IRR. In other instances large discrepancies are possible, and the use of standardised EVA as an indication of true excess return is potentially misleading.

Date: 2005
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DOI: 10.1080/10800379.2005.12106394

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