Solution 1:

Divisional cost of capital: 11%

Requirement: Economic NOPAT, Economic Capital base
EVA for 2000: $31,361
R&D Adjustments

($000s)
R&D Expense
Amortization Period

R&D Amortization under EVA

Cumulative R&D Expense
(P&L)
Less: Cumulative Amortization
(EVA)
Amortized R&D for EVA Calc of
Capital

1995
1996
1997
1998
1999
2000

1995
10673

1996
12487

1997
14610

1998
17094

1999
20000

2135

2135
2497

2135
2497
2922

2135
2497
2922
3419

2135
2497
2922
3419
4000

2135

4632

7554

10973

14973

2497
2922
3419
4000
7800
20638

10673

23160

37770

54864

74864

113864

2135

6767

14321

25293

40266

60904

8538

16393

23449

29571

34598

52960

Advertising Adjustments
($000s)
Adv Expense
Amortization Period

Adv Amortization under EVA

Cumulative Adv Expense (P&L)
Less: Cumulative Amortization (EVA)
Capitalized Adv for EVA Calc of Capital

1998 1999 2000

41
45
50
1996
1997
1998
1999
2000

11
13
14

13
14
15

14
15
17

38
113
73

42
158
114

45
208
160

40

44

48

2000
39000

NOPAT
($000s)
NOPAT
Net Income before Tax
R&D Expense
R&D Adjustment
Adv Expense
Adv Adjustment
Goodwill Amortization
Net Operating Profit Before Taxes
Income Tax Payments
NOPAT

1999

2000

20000
20000
-14973
45
-42
2500
27531
-7875
19656

51000
39000
-20638
50
-45
2500
71866
-18725
53141

1999
110000
34598
44
7500
152142
-16736

2000
135000
52960
48
10000
198008
-21781

2920

31361

EVA
CAPITAL
Net Operating Assets
Capitalized R&D
Capitalize Adv
Accumulated Goodwill Amortization
Capital
Capital Charge
EVA

Solution 2:

Target Bonus = Salary*Fixed Rate = 200,000*60% = 120,000

Addition to bonus bank = 120,000*(1+unexpected EVA improvement/interval)
= 120,000*(1+28441/12000)
= 382,897
Opening balance of bonus bank in 2000 = 0
Bonus payout in 2000 = 120,000 + 0.5*remaining balance = 120,000 + 0.5*(382,897-120,000)
= 251,449

Solution 3:
EVA forces balance sheet accountability and helps manage EVA drivers, increasing firm value. But,
determining EVA is tough. EVA is good for measuring business performance but not so good at
measuring compensation.
The major reasons for this are:
1. The point of a good performance measure is to measure based on the Managers
Controllables. The EVA structure at Vyaderm does not do so. For example, a Regional
Divisional Presidents bonus was a function of Global Business and Regional Business
(weighted 50% and 50% respectively). Regional business would be in her control but the
business in that geography would not and her bonus should ideally reflect that lack of
control.
2. This system holds the manager responsible for extraneous Uncontrollables as well. What
happened with the North American Dermatology Division was a one-time only deal that had
nothing to do with the performance of its managers. There is no need to reward them to
such an extent and set a precedent.
3. EVA is backward looking. It focuses on past performance rather than what managers are
doing to create future shareholder value.
4. The constant up and downs of bonus banks will have a negative emotional impact on staff
morale especially if they can do nothing to control it personally. This system does not take
into account this aspect of human psychology. Also, if the EVA Bank Balance has been
negative for a couple of years, it will be really difficult to get to a positive zone and could
actually de-motivate managers, leading to employee turnover.
5. EVA does not provide good line of sight. In the traditional compensation system, managers
have a good line of sight of the performance measure. For example, A sales manager needs
to boost period sales, an operating manager needs to cut down on fixed and variable costs
etc. With the EVA structure this direct line of sight is lost and is replaced by EVA targets set
at executive level. Translating EVA targets to day-to-day objectives could be difficult at lower
echelons of management.
6. Contrary to claims, the current EVA structure does not provide managers an incentive to
perform above par because a significant portion of their bonus comes from Uncontrollables.
Their utility curve will result in a point where their bonus is maximized vis--vis their effort
and they will stick to this level. This is because additional effort will have such a small effect
on total bonus (because of the Uncontrollables) that the cost of that effort will not be met.