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We applaud Gary Burkette and Timothy Hedley for their article 'The Truth About Economic Value Added" (July 1997). They successfully presented the basic ideas of EVA and appropriately described its still-growing popularity among organizations and investors.

We understand that their self-described "simple example" was intended to be illustrative and, as such, should not be held to an "all encompassing" standard. However, we believe that the following clarifications should be made to assure that readers--for whom this may have been a first exposure to EVA--will not be misled:

Step 1

of the example should include the comment that "beta" is used to quantify the risk related specifically to the company. For the average-risk company, beta would be 1.0, more risky entities would be greater than 1.0, less risky would be less than 1.0.

Step 2

should mention that the cost of debt (6.2%) is after-tax.

Step 3

of the example should mention that interest expense is added back because the return to creditors is part of the determination (in Step 2) of the weighted average cost of capital. It should also be mentioned that adjustment is made for noncash charges (or credits, for that matter) because, in general, these are not part of the company's operating activities.

Step 4

should mention (as pointed out on page 48) that these adjustments are made by some but not all companies.

Step 5

compiles accounting book values which are then used in Step 7 (employing the equation from Step 2) to calculate the cost of capital. It should be mentioned that most analysts believe that market values, rather than book values, should be used to calculate the weights.

Finally, readers should be reminded that economic profit is a single-period measure that may or may not be a reliable indicator of long-term performance. The value of the firm is determined by all of the expected future economic profits and not by the past economic profits.

John P. McAllister, CPA, Ph.D.

Tom W. Miller, D.B.A.

Kennesaw State University


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