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101 Concepts for the Level I Exam

Essential Concept 56: Residual Income, Economic Value Added (EVA), and Market Value Added (MVA)


Residual income is defined as the earnings for a given period minus the opportunity cost of equity holders. It can be calculated in two ways:

Residual income = net income – (equity capital x cost of equity)

Residual income = EBIT (1 – tax rate) – (total capital x WACC)

 

EVA is a commercial implementation of the residual income concept.

EVA = NOPAT – (C% * TC)

where,

NOPAT = company’s net profit after taxes

C% = cost of capital

TC = total capital.

MVA is based on the idea that a company must generate economic profit for its market value to increase.

MVA = Market value of the company – Accounting book value of total capital