This pages cover practice CPA questions that cover economic value (EVA) added, return on assets and return on equity.
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Economic Value Added (EVA®) is an adaptation of residual income that has been adopted by many companies.3 Under EVA, companies often modify their accounting principles in various ways. For example, funds used for research and development are often treated as investments rather than as expenses.4 These complications are best dealt with in a more advanced course; in this text we will not draw any distinction between residual income and EVA. When residual income or EVA is used to measure performance, the objective is to maximize the total amount of residual income or EVA, not to maximize ROI. This is an important distinction. If the objective were to maximize ROI, then every company should divest all of its products except the single product with the highest ROI.
Economic value added (EVA) is a measure of a company’s financial performance based on the residual wealth calculated by deducting its cost of capital from its operating profit, adjusted for taxes on a cash basis.
Return on equity
The return on total assets looks at profits relative to total assets, whereas the return on equity looks at profits relative to the book value of stockholders’ equity.
Return on equity (ROE) is a measure of profitability that calculates how many dollars of profit a company generates with each dollar of shareholders’ equity. The formula for ROE is: ROE = Net Income/Shareholders’Equity. ROE is sometimes called “return on net worth.”
Return on assets:
Return on Assets (ROA) is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company’s annual earnings by its totalassets, ROA is displayed as a percentage.