According to Stern Stewart, the market premium of bearing risk is about 6 percent over the return on long-term government bonds. This market premium should be adjusted to reflect company-specific risk by multiplying the 6 percent by the company's Beta. Given these components, actual adjusted operating income after taxes and cost of capital, a corporate EVA falls out as the difference between the two numbers. A positive EVA means company results exceeded the cost of funds required to produce the operating results, i.e., the company created value for its shareholders and this added-value should be reflected in its stock price. A negative EVA means the company lost value and the resultant should be a corresponding lower return to stockholders.
Total capital is the sum of total equity and total interest-bearing debt.
Return on capital is the actual percentage return earned by the corporation. The spread between return on capital and cost of capital percentages is the determinant of the EVA metric. By emphasizing the cost of capital percentage, individual capital expenditures and performance of divisions, subsidiaries, or business segments can be evaluated in an EVA framework. In concept, this practice of EVA is a residual income analysis. Residual income, the idea of levying a charge on investment, is not a new idea.