Chapter 5. Pick a Name, Any Name: Economic Profit, Residual Income, or Economic Value Added

Abstract Economic value added (EVA) is based on the concept of residual income. For the financial accountant, there is no cost for equity capital. However, for the financial economist, a cost is associated with the use of equity capital—the opportunity cost of these funds. After considering this cost, we have the residual income. Still, EVA is more than residual income; it is also intended to eliminate the "distortions" created by the financial accountant that make no economic sense. The primary purpose of EVA is to provide an answer to the question, is management creating value for its shareholders? However, to think that EVA is simply about calculating a number—as informative as that might be—would miss an important point. In short, the intent is to use EVA as a behavioral tool to alter capital utilization and other incentives rather than as a tool of financial analysis.