For What It's Worth

EVA's roots go back 40 years to corporate finance studies done by economists Merton Miller and Franco Modigliani. Miller later won a Nobel Prize for research that found for businesspeople to accurately estimate whether they're building the value of a business, they have to subtract the cost of capital from the expected return on any capital investment.

Related concepts, such as net present value, discounted cash flow and residual income, all start with the same idea: Before deciding whether to plow money into something (or to leave money that's already been plowed in untouched), you have to consider what you could earn with that money if it were invested elsewhere.

"EVA is a measure of profits, properly calculated," says Al Ehrbar, a Stern Stewart senior vice president and author of EVA: The Real Key to Creating Wealth (John Wiley and Sons). Most simply put, EVA is net operating profit minus an appropriate charge for the opportunity cost of all capital invested in an enterprise.

Simple? On paper, yes. The basic calculation is something capital-strapped entrepreneurs figure on the fly almost daily. But EVA as practiced by Stern Stewart and others can get pretty complex.

This article was originally published in the December 1998 print edition of Entrepreneur with the headline: For What It's Worth.