Talk:Economic value added/Archives/2013
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What are the five or seven key adjustments you can make to affect EVA?
In the summary the following is stated.
...There are potentially over 160 adjustments that could be made but in practice only five or seven key ones are made, depending on the company and the industry it competes in.
I am curious as to what those five to seven key adjustments are.
Cheers.
Russjhammond (talk) 15:50, 18 December 2012 (UTC) — Preceding unsigned comment added by 199.204.60.82 (talk) 15:45, 18 December 2012 (UTC)
Did someone confuse ex post with ex ante again?
I believe the professionals need to go back to work and revise the way they calculate Economic Value Added and economic profit. The current definition fails to account for the fact that investors' required rate of return factors in risks associated with economic and/or financial distress that could result in default (debt) or bankruptcy (equity investors). For that matter, required rate of return also factors in risk of achieving a lower rate of return even if the firm doesn't experience real distress.
Of course, investors won't be compensated for risk that can be diversified away - the risks unique to a particular company. However, even the market risk premium is priced to reflect the variability in returns and risks of economic/financial distress.
The implication is that a firm which delivers precisely the rate of return required by investors has, in fact, created economic value and added economic profit. To help make it more intuitive: suppose a firm borrows from a bank at 10% APR, where the bank has estimated a 1% probability of default. The bank's expected rate of return isn't 10%, it's 10% less (1% x expected $ lost in default). The firm that pays back the loan in full, on time and with all interest require, has added economic profit to the bank - it has to, in order to offset the economic cost of the 1% that default, or the bank can't stay in business.
I'm still trying to nail down how to quantify this. However, given that any expected rate of return over and above the risk-free rate is, in fact, the price of risk, I'm inclined to suspect that economic profit essentially amounts to any returns over and above the risk-free rate.Kelly J Bailey (talk) 04:16, 28 February 2013 (UTC)