Guide: Prof Abhilash S Nair
Vyaderm Pharmaceuticals
Submitted by: Student Name
Student Name
Mohammed Anzy S
Raymond Amalraj
Arvind Gupta
Siva Kumar NV
Gautam Sethi
Company Background: Company founded in 1945. Multinational, multi-product Has focused on Earnings per share Bonus system for managers: based on various operating results and on a subjective evaluation 1997: New CEO- decides to change bonus system
What is EVA (Economic Value Added): Used to be called as Residual Income Stern Stewart & Co. re-named it Economic Value Added Needs to define as EVA
Advantage of EVA: You get a number (dollars, euros, etc.) You are calculating the shareholder value-added by operations (not just increase in sales,for example) You are ”correcting” GAAP numbers for various problem areas of traditional accounting numbers
Disadvantage of EVA: Expensive to make adjustments to GAAP income The accounting adjustments seem a little ”strange.” (Is the GAAP income really ”true and fair?”) Employees may lose confidence in the accounting system
Problem Defination: The Dermatology (skin care) division has a lucky opportunity when their main competitor gets into trouble with the US Food and Drug Administration (FDA) As a result, in year 2000, the Dermatology division has a really profitable, unusual year, In years 2001 and forward, this temporary advantage is expected to be lost
The above statement is proved after calculation the EVA for year 2001 and 2002:
EVA Calculation: Dermatology: 1999a
($000)
2001Ec
2000
2002Ec
NOPAT: Net Income Before Tax $ Research & Development Expense 1. R&D Adjustment Advertising Expense 2. Advertising Adjustment 3. Goodwill Amortization Net Current Operating Profits Before Taxes Current Year's Income Tax Paymentsb Net Operating Proft After Taxes (NOPAT) $
20,000 $ 20,000 (14,973) 45 (41) 2,500 27,531 (7,875) 19,656 $
51,000 $ 39,000 (20,638) 50 (46) 2,500 71,866 (18,725) 53,141 $
27,848 $ 27,378 (23,616) 55 60 2,500 34,114 (10,622) 23,493 $
32,861 32,032 (27,101) 61 (55) 2,500 40,297 12376 27,921
CAPITAL: Net Operating Assets 1. Capitalized R&D 2. Capitalized Advertising 3. Accumulated Goodwill Amortization Capital
110,000 34,598 44 7,500 152,142
135,000 52,960 48 10,000 198,008
153,164 56,721 53 12,500 222,439
180,734 61,653 59 15,000 257,445
$
$
Capital Charge (11%) Economic Value Added (EVA) a
$
$
(16,736) $
2,920
$
$
(21,781) $
31,360
$
$
(24,468) $
(975) $
(28,319) (398)
EVA w as introduced in the Derm atology Division in 2000. The 1999 EVA figures w as calculated retroactively solely to set 2000 EVA targets. The 1999 EVA calculation includes am ortizations of 1995 R&D expense of $10,673.
b
Taxes = 35% of (Net Incom e Before Tax + Goodw ill Am ortization)
c
2001 and 2002 estim ated results obtained by forecasting four financial statem ent item s at historical grow th rates from 1999 base: net incom e before tax at 18%, R&D at 17%, consum er advertising at 10% and net operating assets at 18%.
The above value indicates that the EVA value reduced drastically in year 2001 and 2002.
Calculation of Bonus: ($000 except bonus) Economic Value Added (EVA) EVA Improvement Goal EVA Target Interval
1999 2000 2001E 2002E Old Model EVA Year 1 EVA Year 2 EVA Year 3 $ 2,920 $ 31,360 $ (976) $ (398) 2,150 2,510 2,510 5,070 33,510 1,174 12,000 12,000 12,000
Actual EVA Improvement EVA Performance North American Manager's Bonus Base Salary Target EVA Bonus (60% Base Salary) Starting Bank Balance 1. Calculated Bonus New Bank Balance
$
$
28,440 $ 319%
200,000 120,000
$
382,897 382,897
Pay Out 100% of Available Target Plus 50% Remaining Bank Balance 2. Total Bonus Payout
$
120,000 131,449 251,449
Ending Bank Balance
$
131,449
$
(32,336) -187%
200,000 120,000
578 87%
$
131,449 (224,858) $ (93,410) $
200,000 120,000 (93,410) 104,279 10,869 10,869
$
(93,410)
Bonus payout in 2000 was very good, but as bank balance had been reduced in 2001, bonus payout had been reduced, so EVA system does not prove to be right.
What company must do to solve the problem? 1. Company must reduce the Bonus and set the precedent, so that does not create higher expectations 2. Try to change the plan calculations, so that EVA for other years can also be positive
We need to make sure that goal of financial management are following to achieve to avoid any dissatisfaction in stakeholders: Maximize shareholders’ wealth Harmonize managers of many units of firm Connect managers’ decision to overall corporate goals in lower divisions Managers must perceive relation between their decisions, corporate goals, and compensation
