Submitted by: Submitted by gaiaber
Views: 330
Words: 298
Pages: 2
Category: Business and Industry
Date Submitted: 09/12/2012 10:50 AM
Duckworth Industries Inc.
Duckworth is a holding company for Worth Corp., HES and HTS
John Duckworth wants to change the management incentive compensation systems
Needs to align more closely the interests of management and shareholders
The Current Incentive Plans:
(1) Attendance Bonus (4) Individual Incentive Plan
(2) Quality Incentive Plan (5) Annual Incentive Plan
(3) Profit-Sharing Plan (6) Long-Term Incentive Plan
The New EVA System:
New management incentive plan that promises to link management pay directly to the creation of long-run economic value for shareholders
Implementation requires the services of Stern Stewart & Co., a financial consulting firm
Economic value is created when the rate of return on invested capital exceeds the cost of capital
EVA should equal avg. capital employed x the difference between the cost of capital and the return on capital earned
EVA uses Economic Income as opposed to Accounting Income, therefore, certain adjustments must made before EVA can be calculated
Management will be directly compensated for adding value via a compensation formula
Key drivers of EVA: (1) NOPAT (2) Avg. Capital (3) Cost of Capital
EVA = NOPAT – cK NOPAT: net operating profit after tax
c: Weighted Average cost of capital
K: Capital Employed
Example: NOPAT = 100,000, c = 15,000, K = 6
EVA = 100,000 – (15,000)(6) = 10,000
Typical Distortions:
1) LIFO Inventory 3) Amortization of Goodwill
2) Deferred Tax Expense 4) Research and Development
Benefits of EVA:
It focuses managers on generating returns in excess of the cost of capital entrusted to them
Links capital budgeting & investment decisions
Goal congruence
Strong link with shareholder value
Disadvantages of EVA:
Complex, considerable data analysis
Does not work well with all companies
It...