The spreadsheet contains calculation of Economic Value Addition for Bonus Payment. This case "VYADERM PHARMACEUTICALS" was taught in Executive Compensation subject at XLRI
EVA Calculations
Vyaderm Solution
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Vyaderm Pharmaceuticals Case Assignment Advanced Corporate Finance
Submitted By: S.No 1 2 3 4 5
Name Abhishek Kumar Singh Deepak Mittal Kiran Babu S Sanjay Kumar Parida Vivek Talwar
Roll No EPGP-04A-005 EPGP-04A-026 EPGP-04B-041 EPGP-04A-084 EPGP-04A-113
Case Summary Vyaderm started its operations since 1945 and was doing well. Vedrine took over as CEO from Finn. Since Vedrine took over, the profitability began to slip and Vedrine was under lot of pressure. Vedrine intended to implement EVA approach for the performance measure. •
EVA = Net profit after taxes – (Capital x cost of Capital)
Under GAAP, R&D expenditure is amortized on straight line basis over 5 years. Under GAAP, Advertising expenditure is amortized on straight line basis over 3 years. Under GAAP, Goodwill is amortized on straight line basis over 40 years.
Amortization Estimation The estimation for amortization of these expenditures is given below:
R&D Amortization Schedule for 2000 Year R&D expenses
Amortization for EVA Adjustment
R&D Amortization for 2000 and 2001 Cumulative R&D expenses Less cumulative amortization Capitalized R&D for 2000 and 2001 EVA
Advertisement Amortization Schedule for 2000 Year Advertising expenses
Amortization for EVA Adjustment
1996 1997 1998 1999 2000 2001
Advertising Amortization for 2000 and 2001 Cumulative advertising expenses Less cumulative amortization Capitalized Advertising for 2000 and 2001 EVA
1996 34 11
11 34 11
1997 38 11 13
24 72 35
1998 41 11 13 14
38 113 73
1999 45 13 14 15
42 158 115
2000 50
14 15 17
2001 55
15 17 18
46 208 161
50 263 211
47
52
Goodwill Amortization Schedule for 2000 Year Goodwill expenses
Amortization for EVA Adjustment
Goodwill Amortization for 2000 and 2001 Cumulative Goodwill expenses Less cumulative amortization Capitalized Goodwill for 2000 and
1996 0 199 6 199 7 199 8 199 9 200 0 200 1
1997 2500
1998 2500
1999 2500
2000 2500
2001 2500
63
63
63
63
63
63
63
63
63
63
63
63
63
63 63
0 0 0
63 2500 63
126 5000 189
189 7500 378
252 10000 630 9370
315 12500 945 11555
2001 EVA EVA has 3 elements: EVA centers, EVA drivers and EVA-based incentive program. For the EVA based incentive program, a target bonus is set. The payout of the targeted bonus depended on the performance of the relevant EVA centre’s to which the manager is assigned. So the bonus is dependent upon the EVA target and EVA interval. EVA performance = 1+ ((Actual Imrovement-Imrovement Goal)/ Interval) Calculated Bonus = Target Bonus x EVA Performance Year 2000 Divisional Manager’s Salary = $200000 Bonus target = 60% of salary = 120000 EVA Improvement goal = $2150 EVA Target = $5070 EVA Interval = $12000
As per the formula and Table A the bonus of the Manager can be determined.
Case Analysis The introduction of the EVA system had some obvious positive effects on the stock price of the company. However they begin to fall after March 2000. 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.
Recommendations
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. But we believe that the way the bonus is being calculated right now will not be accepted for long because of the various problems outlined. We suggest assigning goal weights in such a way so as to measure Controllable to a maximum.
