Why do we calculate with EBIT and not NOPAT when calculating EVA = EBIT - CE*WACC?

Question

Hi, my accounting background isn't very strong and my question is:
in Question 2A We are being asked to calculate the EVA (Economic value added)
EVA = EBIT - CE*WACC
But why not
EVA = NOPAT- CE*WACC?

Is it because EBIT is being provided in the study and NOPAT isn't?

Thanks in advance!

Answer 1

Hey there 🙂, we typically use EBIT in the EVA calculation because it represents the operating profit before the effects of financing and taxes, allowing for a more consistent comparison of operational performance. If you used NOPAT, which is after-tax profit, you'd have to account for tax effects separately, and it might not align as cleanly with the capital charge (CE * WACC) provided. In many studies, they use EBIT simply because that's the figure available and it keeps the analysis straightforward. Best, Alessa 😇

Answer 2

Hi there,

you are technically right. EVA reflects the true economic profit/return to both debt and equity holders. Hence, we need to account for taxes while not considering the interest (as this is the debt holders return) --> NOPAT

However, you will encounter in many Consulting interviews that it is rather about testing the overarching concept than being precisely right. Hence, for simplicity they use EBIT here. If I would interview you, I would give you bonus points for pointing out that NOPAT would be better though ;)

Keep in mind that a lot of interviews are more about being 80:20 but fast :)

Best,
Sebastian

Answer 3

You are technically correct. EBIT is an approximation, whereas NOPAT is the right way to calculate.