Measurement of value creation: economic value added and net present value

Abstract

There are some major frameworks within value based management system. This paper analyses the two most basic approaches – economic value added (EVA) and discounted cash flows (DCF) techniques – that are used to measure value creation of companies. These models are frequently applied in company’s valuation and investment project valuation. EVA and NPV measures are consistent with the maximization of the value of the company. Investments, cash flows, economic life and capital cost are financial market’s actuality, where value and profitability should be measured. Therefore DCF models are applied there and companies’ economic data can be obtained from here. Each investment is evaluated of future decisions over its useful life based on the expected cash flows. The result is net present value (NPV) and a positive NPV show that investment creates value. EVA is calculated over a defined calendar period. It measures an entire company’s current economic performance. A positive EVA signals value creation. The concept of NOPAT is basic to both approaches. Each approach requires a variety of adjustments to the accounting information. Although DCF and EVA approaches can provide the same present value expression, there are differences between these approaches. Some of them are technical and therefore NPV analysis is the business analysts’ preferred method to estimate value and to make long-term decisions.