Chapter 19 – Strategic Performance Measurement—Investment Centers
19-45 EVA® NOPAT and EVA® Capital; Financing Approach (60 Minutes)
1. Students should understand that EVA® is an approximation of an entity’s true (i.e., “economic”) profits
for a period. This measure of profitability is defined as the difference between the entity’s NOPAT (net
operating profits after tax) and an imputed capital charge. NOPAT is supposed to approximate the
entity’s actual cash yield generated for investors from recurring business activities during the period.
The amount of capital employed is supposed to represent the cash that investors have put at risk in
the firm, and upon which they expect an appropriate return. To estimate both NOPAT and the amount
1. EVA® NOPAT—Financing Approach:
Income available to common $30
Plus: Equity-Equivalent (EE) Adjustments:
Increase in Deferred Tax account (1) $5
Chapter 19 – Strategic Performance Measurement—Investment Centers
Tax Savings (Foregone) on Interest (4) 10
Interest Expense after Income Tax Effects 16
EVA® NOPAT $53
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Chapter 19 – Strategic Performance Measurement—Investment Centers
19-45 (Continued-1)
Rationale for above (EE) adjustments:
(1) Change in Deferred Tax account: this adjustment converts reported tax expense to approximate
the amount of cash tax expense
(2) Increase in LIFO reserve: this adjustment converts LIFO (i.e., “old“) cost of goods sold to more
current values (assuming period of rising prices).
2. EVA® Capital—Financing Approach:
Total debt + leases:
Short-term Interest-bearing debt (10%) $100
Long-term Interest-bearing debt (8%) 150
PV of non-capitalized leases (1) 50
Other long-term liabilities 120 $420
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Chapter 19 – Strategic Performance Measurement—Investment Centers
Rationale for above changes:
(1) PV of non-capitalized leases: this adjustment is needed to bring consistency between the
treatment of capital and operating leases, in terms of presenting an estimate of the amount of
“capital” employed during the period.
19-45 (Continued-2)
(2) LIFO Reserve: the entire amount of the LIFO reserve is added as an adjustment. This adjustment
3. EVA®:
EVA® NOPAT = $53
Capital Charge:
EVA® Capital = $925
WACC = 10.70% $99
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Chapter 19 – Strategic Performance Measurement—Investment Centers
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Chapter 19 – Strategic Performance Measurement—Investment Centers
19-46 EVA®, Shareholder Value Analysis, and Sustainability; Internet-Based Research (90 Minutes,
including search time)
1. Economic Value Added (EVA®) is essentially a measure of economic profit during a period. EVA® for a
given period can be estimated as follows:
EVA® = NOPAT – Imputed Charge for the Use of Capital (Assets) During the Period
= NOPAT – (k × Average Invested Capital)
= After-tax cash operating income, after depreciation – (k × Average Invested Capital)
= Revenues – Cash Operating Costs – Depreciation – Cash Taxes on Operating Income
where: k = cost of capital (e.g., weighted-average cost of capital), and
Capital = Economic Capital = Cash Contributed by Suppliers of Funds to the Business Unit
(or firm as a whole)
Notice that relative to an accounting-based approach to income determination (which is based on
accrual concepts), EVA® is attempts to measure economic profit for a period (i.e., the amount of
value added to the firm during a period). On the surface, the EVA® formula looks similar to residual
income (RI). However, RI relies on accounting-based estimates of both income and capital, while
EVA® is based on economic concepts for these variables. Put another way, the EVA® calculation
begins with accounting-based measures, then adjusts these to better approximate the amount of
economic earnings (or, value added) during a period.
2. The key here is to view the constituent parts of EVA® as a guide for evaluating the contribution of
sustainability-related initiatives (programs, projects, etc.) to shareholder value, as follows:
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EVA® = Shareholder Value Added = NOPAT – Capital Charge
19-46 (Continued-1)
Thus, shareholder value can be increased either by increasing NOPAT or by decreasing the imputed
capital charge. In turn, NOPAT can be increased in essentially two ways, each of which provides a
basis for assessing the contribution of an investment project (such as a sustainability initiative):
The imputed capital charge is a function of both the amount of capital employed and the cost of
capital (risk, or discount rate). Thus, the charge for capital employed can be reduced (thereby
increasing EVA®, everything else held constant) either through better/more efficient utilization of
assets (e.g., through process simplification or through supply chain streaming) or by reducing the
discount rate (investments in social and/or environmental projects tend to reduce social and/or
political risk, thereby reducing the discount rate).
3. Student responses to this requirement will differ. In his book Making Sustainability Work: Best
Practices in Managing and Measuring Corporate Social, Environmental, and Economic Impacts (San
Francisco, CA: Berrett-Koehler Publishers, Inc.), Marc Epstein offers (p. 141) the following two
examples:
a. DuPont uses a metric called “shareholder value added per pound of production” or SVA/lb. SVA is
defined as “shareholder value created above the cost of capital. A company increases SVA by
adding material, knowledge, or both. SVA/lb. emphasizes the addition of knowledge, rather than
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material. DuPont has used this metric to evaluate its business units and set goals to increase its
SVA/lb. based on those evaluations.
b. Georgia-Pacific used shareholder value analysis to align the company’s goals of creating
shareholder value and environmental responsibility (critically important for a forest-products
company).
19-46 (Continued-2)
The EH&S department at Georgia-Pacific, as well as individual environmental projects, has been
evaluated using shareholder value analysis. Included in each environmental project evaluation is an
assessment of the project’s impact on revenues, operating costs (such as consulting fees, fines, and
administrative costs), and capital costs. Using shareholder analysis, Georgia-Pacific has been able to
identify environmental investments that create financial and stakeholder value for the company.
4. The purpose of this question is to motivate students to think more broadly (e.g., in terms of strategic
performance measurement systems) that could be used to support corporate sustainability initiatives.
Implicit in the discussion is the role of the management accountant in the design of such systems.
Students will likely already have been exposed to the Balanced Scorecard (BSC) as one example of
a strategic management system (or, a strategic performance measurement system). Thus, they might
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In Making Sustainability Work: Best Practices in Managing and Measuring Corporate Social,
Environmental, and Economic Impacts (San Francisco, CA: Berrett-Koehler Publishers, Inc.), Marc
Epstein suggests (p. 138) the following reasons why companies would choose to establish a separate
BSC perspective for sustainability:
19-46 (Continued-3)
1. Social and environmental responsibility is seen as a core to the strategy of the organization,
differentiation), as opposed to being seen as a means to improve operational efficiency.
2. The fifth perspective becomes a tool to focus the attention of managers on social and
environmental responsibility as a core corporate value. It communicates management’s strong
concern about these issues and objectives.
3. When a company has high-profile or high-impact social and environmental issues, a fifth
In the course of their information search, students may have encountered reference to the BSC that Nike
developed to help identify the reason for noncompliance on sustainability by their suppliers or to
Unilever’s decentralized efforts to achieve an overall goal of reducing the company’s “environmental
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