EVA – A CATHARTIC CHANGE?!
Prof. Zhaoyang Gu
EVA: North American Dermatology Division
We will first calculate the 1999 actual EVA retroactively and if our figure matches Vyaderm’s then we will use that method to calculate EVA for 2000 and 2001.
1999 EVA Calculation:
|In ‘000s |1999 |
|Operating earnings |20,000 |
|add R& D expense |20,000 |
|minus R & D amort. |14,972.8 |
|add ad expense |45 |
|minus ad amort. |41.34 |
|add goodwill |2500 |
|NOPBT |27530.86 |
|less taxes |7875 |
|NOPAT |19655.86 |
|In ‘000s |1999 |
|NOA |110000 |
|add cap R&D |34597.8 |
|add ad expense |43.66 |
|add acc. goodwill |7500 |
|Capital |152141.46 |
EVA = NOPAT – [Capital * Cost of Capital]
EVA = 19655.86 – [152141.46 * 0.11]
EVA = 2920.29 ~ 2920
Since this is the figure calculated by Vyaderm, we have arrived at the figures presented below using the same technique.
The figures requested by Maurice Vedrine:
• 2000 EVA for the North American Division – $31,361,000 • 2000 EVA bonus payout - $252,000
• 2001 EVA for the North American Division – $(6,587,000) • 2001 EVA bonus payout - $0
The numbers used for the calculation of division EVA are presented in Exhibit 1. These were used to arrive at the report given in Exhibit 2. The methodology and assumptions for 2001 are outlined in Exhibit 3. As is evident from the ending bank balance of the manager for 2001, not only will she not get any bonus for the year 2001 but will have to work off the negative balance for the year 2002 and onwards. However, the lump sum she gets in 2000 is very large compared to her usual annual bonus. In fact it is more than 4 times her bonus in 1999. Since she knows her bonus may not materialize for many years (it depends on factors that are not entirely in her control), what’s stopping her from taking the bonus this year and quitting the next?
The current system is obviously flawed but not irredeemably so. One suggestion is having a cap and a threshold for bonus payouts of exceptionally good and bad years respectively. This does not mean that the manager’s earned bonus will be capped for good years, it will just stay in his bonus bank. Similarly for really bad years some threshold payout will still be made and in case the bank balance is zero or negative it will be treated as a loan from the company which has to be paid back interest free, the manager will have the option of refusing this loan.
The next sections deal with a thorough analysis of EVA at Vyaderm and our recommendations based on the above anomaly in the system.
The Merits of EVA: An Evaluation
To evaluate the claims made in the Executive presentation, we have looked at all six claims individually and tried to analyze each in the context of Vyaderm. The first three points are related to the traditional system.
1. Caps limit incentive for exceptional performance
o Once a salesperson/manager achieves their cap, there is no incentive to go beyond the cap. Though there is no explicit reference to how the caps were set in Vyaderm, but the case does mention that the old compensation system included an annual bonus. 50% of the bonus was based on objective operative results. The other 50% was based on subjective evaluation of the manager’s personal contribution. Furthermore, an inherent flaw in the system was managers spending more time negotiating the subjective part of their bonus rather than...