Economic Value-added Analysis

1. 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

2. Sources of Capital -Debt -Equity Capital Buys “Stuff” “Stuff” Generates Income Let’s Define EVA™ When the Cost of Capital is less than the Operating Income from that Capital, you create EVA™!!!

3. EVA™ Elements • Cost of Debt Financing • Cost of Equity Financing • Components of Capital • Adjusted Net Operating Income

4. Cost of Debt Financing • Interest Expense • After-tax Impact • Consider all Debt, Excluding A/P

5. Cost of Equity Financing • Shareholder Hurdle Rate • Price Appreciation • Dividend Rate • “Six Percentage Point” Rule

6. Components of Capital • Net Working Capital • Net Long-lived Tangible Assets • R & D Spending • Employee Development Spending

7. Adjusted Net Operating Income • Substitute R&D 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

8. EVA™ Uses • Planning Tool • Business Unit Evaluation • Incentive Compensation Base • Merger and Acquisition Analysis • Capital Asset Analysis

9. Corporate Examples • CSX • Quaker Oats

10. Ways to Raise EVA™ • Increase Profits • Reduce Capital Spending • Reduce Investment in Working Capital • Increase High-margin Capital Investments

11. Stern Stewart’s Implementation Hints • Top management buy-in • Make it a way of life • Implement Gradually • Keep it Simple • Train the users