The economic value added (EVA) is a more precise version of the residual income (RI).

The residual income computes for the excess of the income earned over the desired income.

When calculating for the EVA, the after-tax operating income is used instead of simply operating income, and current liabilities are deducted from total assets in the computation of desired income.

## Economic Value Added (EVA) Formula

The formula in computing for the economic value added is:

EVA | = | After-tax operating income - Desired income |

where:

After-tax operating income = Operating income x (1 - Tax rate)

Desired income = Minimum required rate of return x (Assets - Current liabilities)

**Note:** In most cases, the minimum required rate of return is equal to the *cost of capital*. The *average* of the assets and *average* of current liabilities are used if possible.

## Example: Computation of EVA

Compute for the economic value added of an investment center which had operating income of $380,000, average operating assets of $1,200,000, and average current liabilities of $300,000. The cost of capital is 12%. The company is subject to 40% taxes.

After-tax operating income | = | Operating income x (1 - Tax rate) |

= | $380,000 x (1 - 40%) | |

After-tax operating income | = | $228,000 |

Desired income | = | Minimum ROR x (Operating assets - Current liabilities) |

= | 12% x ($1,200,000 - 300,000) | |

Desired income | = | $108,000 |

EVA | = | After-tax operating income - Desired income |

= | $228,000 - $108,000 | |

EVA | = | $120,000 |

The subunit made $120,000 after-tax income above its desired or minimum income. The higher the economic value added, the better.