1. Managing Costs and Revenues--MBA I--Spring 2009 6-1 Managing Costs & Revenues Professor William F. O’Brien, MBA, CPA Spring 2009

2. Managing Costs and Revenues--MBA I--Spring 2009 6-2 Session 6 EVA ® The Goal Reichard Maschinen Case

3. Managing Costs and Revenues--MBA I--Spring 2009 6-3 Economic Value-added Analysis EVA® Measurement Alternative for Shareholder Value Elements

4. Managing Costs and Revenues--MBA I--Spring 2009 6-4 Let’s Define EVA® When the Cost of Capital is less than the Operating Income from that Capital, you create EVA®!!! Sources of Capital -Debt -Equity “Stuff” Generates Income Capital Buys “Stuff”

5. Managing Costs and Revenues--MBA I--Spring 2009 6-5 EVA® Elements Cost of Debt Financing Cost of Equity Financing Components of Capital Adjusted Net Operating Income

6. Managing Costs and Revenues--MBA I--Spring 2009 6-6 Cost of Debt Financing Interest Expense After-tax Impact Consider all Debt, Excluding A/P

7. Managing Costs and Revenues--MBA I--Spring 2009 6-7 Cost of Equity Financing Shareholder Hurdle Rate Price Appreciation Dividend Rate “Six Percentage Point” Rule

8. Managing Costs and Revenues--MBA I--Spring 2009 6-8 Components of Capital Net Working Capital Net Long-lived Tangible Assets R & D Spending Employee Development Spending

9. Managing Costs and Revenues--MBA I--Spring 2009 6-9 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

10. Managing Costs and Revenues--MBA I--Spring 2009 6-10 EVA® Uses Planning Tool Business Unit Evaluation Incentive Compensation Base Merger and Acquisition Analysis Capital Asset Analysis

11. Managing Costs and Revenues--MBA I--Spring 2009 6-11 Corporate Examples CSX Quaker Oats

12. Managing Costs and Revenues--MBA I--Spring 2009 6-12 Ways to Raise EVA® Increase Profits Reduce Capital Spending Reduce Investment in Working Capital Increase High-margin Capital Investments

13. Managing Costs and Revenues--MBA I--Spring 2009 6-13 EVA® Implementation Top management buy-in Make it a way of life Implement Gradually Keep it Simple Train the users

14. Managing Costs and Revenues--MBA I--Spring 2009 6-14 Theory of Constraints The Concept The Process The Measures

15. Managing Costs and Revenues--MBA I--Spring 2009 6-15 The Concept Presented in Eliyahu Goldratt’s The Goal The goal of a business is to make money…consistent with customer satisfaction Continuous flow Avoid the “herbies” Eliminate the bottlenecks first

16. Managing Costs and Revenues--MBA I--Spring 2009 6-16 The Process Identify the constraints Exploit the constraints (reduce the bottlenecks) Subordinate everything else Elevate the constraints (remove the bottlenecks) Reiterate the process

17. Managing Costs and Revenues--MBA I--Spring 2009 6-17 The Measures Throughput-Net income Inventory-ROI Ops. Expenses-Cash Flow