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Vyadderm
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15.963 Managerial Accounting and Control
Spring 2007
To maximize firm value, the firm must earn more than its
cost of capital.
The third performance metric is in %, but captures the
spirit of two important (and essentially similar) metrics:
Residual income, and
Economic Value Added (EVA).
These differ only in certain details.
EVA is, broadly speaking, = Income – (Expected income)
= Income – (Cost of Capital*Invested Capital).
This is a dollar amount, not percentage, so larger firms will
generally have higher EVA.
Vyaderm
How do you determine the cost of capital for, e.g., the Dermatology
division?
Vyaderm
How do you the determine the investment base for the dermatology
division?
BONUS
INCENTIVE TOTAL BONUS
EARNED
Slope = Target Incentive / EVA Interval
Bank
Payout
Target Incentive
Year 0 Year 1
Actual EVA Target EVA
IMPROVEMENT
Improvement
Goal
EVA Interval
Note: The EVA interval is the shortfall from target that eliminates the bonus.
An EVA center’s performance (%) = 1 + [actual improvement – improvement goal) / EVA interval].
Vyaderm
What is the role of the EVA interval?
It allows risk taking, by allowing positive additions to the bonus bank
even for shortfalls from target.
Allowing managers to take calculated risks, or preventing them from
being overly risk averse, is important.
The shorter the interval, the greater the risk imposed on managers, and the
more risk-averse they might generally be when the bank balance is
positive.
On the other hand, they might also engage in excessive risk taking when
the balance is hopelessly negative.
It acts as a lever for bonus payments.
The bonus payment per dollar of improvement beyond the bottom of the
interval is (target bonus / interval).
The shorter the interval, the higher the payment per dollar of EVA
improvement, and the greater the risk imposed on managers.
This is the risk/reward tradeoff.
Vyaderm
Vyaderm
R&D Expense as Reported on P&L 10673 12487 14610 17094 20000 39000 27378 32032
R&D Amortization Under EVA 2135 4632 7554 10973 14973 20638 23616 27101
Cumulative R&D Expense (P&L) 10673 23160 37770 54864 74864 113864 141242 173274
Less: Cumulative Amortization (EVA) 2135 6767 14321 25293 40266 60904 84521 111622
Capitalized R&D for EVA Calculation of Capital 8538 16393 23449 29571 34598 52960 56721 61652
Advertising Adjustments
NOPAT:
Net Income Before Tax 20000 51000 27848 32861
Research & Development Expense 20000 39000 27378 32032
1. R&D Adjustment -14973 -20638 -23616 -27101
Advertising Expense 45 50 55 61
2. Advertising Adjustment -41 -46 -50 -55
3. Goodwill Amortization 2500 2500 2500 2500
Net Operating Profit Before Taxes (NOPBT) 27531 71866 34114 40297
Current Year's Income Tax Payments -7875 -18725 -10622 -12376
Net Operating Profit After Taxes (NOPAT) 19656 53141 23493 27921
CAPITAL:
Net Operating Assets (NOA) 110000 135000 153164 180734
1. Capitalized R&D 34598 52960 56721 61653
2. Capitalized Advertising 44 48 53 59
3. Accumulated Goodwill Amortization 7500 10000 12500 15000
Capital 152142 198008 222439 257445