A financial model to determine the distortions in Economic Value Added (EVA) caused by inflation

Abstract

This paper presents an algebraic model to study the extent to which inflation distorts Economic Value Added (EVA). The model consists of a theoretical firm in steady state, consisting entirely of projects with the same known internal rate of return. The EVA this firm reports is then calculated, and compared to the true economic profit calculated from the known return of the firm. The model shows that both conventional EVA and EVA based on the current value of assets are distorted by inflation. The distortion in the latter is more systematic, and this could form the basis of an adjusted EVA calculation to provide an estimate actual profitability.