Duckworth Industries

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...