Session 10A--EVA

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Session 10A--EVA
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Economic Value-added Analysis

• Brainchild of Stern-Stewart
• Popularized in Fortune Magazine
• Alternative methods of computation
• Horngren
• Stern-Stewart
• Excellent as an internal measure
• Hints for implementation

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Lets Define EVA
When the Cost of Capital is less than the
Operating Income from that Capital, you create
EVA!!!
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EVA Elements

• Cost of Debt Financing
• Cost of Equity Financing
• Components of Capital
• Adjusted Net Operating Income

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Cost of Debt Financing

• Interest Expense
• After-tax Impact
• Consider all Debt, Excluding A/P

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Cost of Equity Financing

• Shareholder Hurdle Rate
• Price Appreciation
• Dividend Rate
• Six Percentage Point Rule

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Components of Capital

• Net Working Capital
• Net Long-lived Tangible Assets
• R D Spending
• Employee Development Spending

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Adjusted Net Operating Income

• Substitute RD and Employee Development Costs
  with Annual Amort.
• Use Net Income from Continuing Operations
• Adj. Net Op. Income Minus Cost of Financing
  Equals Economic Value Added

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EVA Uses

• Planning Tool
• Business Unit Evaluation
• Incentive Compensation Base
• Merger and Acquisition Analysis
• Capital Asset Analysis

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Corporate Examples

• CSX
• Quaker Oats

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Ways to Raise EVA

• Increase Profits
• Reduce Capital Spending
• Reduce Investment in Working Capital
• Increase High-margin Capital Investments

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Stern Stewarts Implementation Hints

• Top management buy-in
• Make it a way of life
• Implement Gradually
• Keep it Simple
• Train the users

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Session 10B--Theory of Constraints and The Goal
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Theory of Constraints

• Eliminate the bottlenecks
• Developed by Goldratt and Cox
• Featured in The Goal

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The Concept

• Presented in Eli Goldratts The Goal
• The goal of a business is to make
  moneyconsistent with customer satisfaction
• Continuous flow
• Avoid the herbies
• Identify and eliminate the bottlenecks

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TOC Implementation

• Identify the binding constraints
• Decide on efficient use of constrained resources
• Manage the flow up to and after the constraint
• Add capacity to the constraint
• Redesign the process

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Driver Based Metrics

• If you want to improve
• Net income
• ROI
• Cash flow
• Monitor
• Throughput
• Inventory
• Operating expensesPOs

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Three Key Questions

• What to change?
• What to change to?
• How to cause the change?

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Lous Ethical Dilemma

• Pro-forma reporting at Bearington
• End was justifiedbut not the means
• 2003 implication
• How would you address the situation?
• Thinking of inventory as a liability