The importance of recognising economic profit or EVA
Owners of businesses could set their managers a straight-forward task. That is to earn a return on their capital they will deploy to exceed the returns shareholders could realistically expect from another firm in the same (risky) line of business. If the managers succeed in this way, that is realise an internal rate of return on the projects they undertake that exceed these required or break even returns, they will be generating an economic profit for their owners. They will have created what is now widely known as Economic Value Added (EVA) in proportion to the amount of capital they put to work. EVA=I*(r-c) where r is the measure of the internal rate of return, c is the required return or as it is sometimes described as the cost of capital and I is the quantum of capital invested.
Continue reading the full paper here: Applying EVA to the holding company