As the following formula:
EVA = (ROIC - WACC) * CAPITAL EMPLOYED
reveals, EVA is based on the accounting rate of return. Unfortunately
accounting rate of return have at least two severe pitfalls:
- Wrong periodizing (EVA is divided unevenly between different years)
- With normal depreciation schedules EVA (and ROI) tend to be small at the beginning of a project and big
at the end of the project. Therefore companies with a lot of new investments have lower EVA than their true profitability
would imply and companies with a lot of old investments have bigger EVA than their true profitability would imply
- Distortions caused by inflation, asset structure etc.
- Historical asset values are distorted by inflation which affects also EVA values
- As proved many times in financial literature; accounting rate of return is also without any inflation unable
to describe (even on average) the true underlying rate of return. The extent of this problem depends on the asset
structure (the relative proportions of current assets, depreciable assets, undepreciable assets) and on the length
of the investment period.
