Earlier article, we see many benefits when deploying the Economic value added computation. However, like any analytical tool, there are still some limitations/ pitfall(s) of EVA namely:-
EVA is still based on an accounting based concept, hence it still suffers the following:
- like other accounting rate of returns for example like the ROI. Using the normal accounting convention of the historical costs concept, asset values are quoted on historical costs unaffected by inflation, the true rate of return is not able to be properly ascertained,
- EVA is distorted by the fact of the upfront normal depreciation being small at the beginning of a project and big at the end of the project. Therefore companies with a lot of new investments have lower EVA than their true profitability would imply and companies with a lot of old investments have bigger EVA than their true profitability would imply. The extent of this challenge depends on the asset structure (the relative proportions of current assets, depreciable assets, un-depreciable assets) and on the length of the investment period. This pattern is similar to the ROI where when we examine a single project the ROI is a poor estimator or the true rate of return, since at the beginning of the project when the capital base is big, the ROI is small and then at the end when the capital base is small then the ROI is big.
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