This question deals with summary financial performance indicators.
Required: 1.Discuss the similarities between ROI,residual income (RI),and EVA$\rarr$.
2.In what sense is EVA$\rarr$ similar to and in what sense is it distinct from residual income (RI)?
3.Present the equation for calculating EVA$\rarr$ and provide a brief discussion of the elements that go into the calculation of EVA$\rarr$.
4.What are the two approaches that can be used to estimate the two major components of EVA$\rarr$? Which of these two approaches is superior?

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Feedback: 1.ROI,RI,and EVA$\rarr$ have the following in common:
(a)they are all summary financial-performance indicators-as such,each can be included as a high-level objective in,say,the balanced scorecard (BSC)of an organization;
(b)each is appropriate for assessing the financial performance of investment centers because each incorporates the level of investment in the performance metric;
(c)each is limited in the sense of assessing only short-run financial performance;and
(d)because they are short-term financial- performance indicators,each can be manipulated by managers-at least to some extent.
2.Both EVA$\rarr$ and residual income (RI)are absolute performance indicators.That is,they represent dollars of earnings (in some form).As such,there use tends to avoid negative behavioral effects associated with the use of a relative performance indicator,such as ROI.(By relative performance indicator,we mean "ratio.")Further,both EVA$\rarr$ and residual income (RI)impute a charge for use of divisional assets (investment in the unit).Thus,it is not until there is a "return of capital" that a "return on capital" is indicated.Finally,both RI and EVA$\rarr$,because they are absolute performance metrics,have an inherent bias toward larger divisions.EVA$\rarr$ and residual income (RI)look similar,on the surface.However,there is a significant difference between the two.RI uses conventional accounting data,for both "operating income" and "investment." As such,the metric is subject to the same limitations as those associated with such data.EVA$\rarr$,on the other hand,attempts to approximate "economic earnings." Thus,both the income figure and the level of invested capital are adjusted to remove what proponents of EVA consider to be "accounting distortions." In fact,Stern Stewart in the classic book on EVA$\rarr$shows approximately 160 such adjustments that can be made to reported accounting data when calculating EVA$\rarr$ for a given company.
3.EVA$\rarr$ = NOPAT - (k x average invested capital),where NOPAT = after-tax cash operating earnings,after depreciation = "total pool of cash funds available to the suppliers of capital" = revenues - cash operating costs - depreciation - cash taxes on operating income,k = an appropriate discount rate (such as the weighted-average cost of capital,WACC),and "invested capital" = "economic capital" = cash contributed by suppliers of funds to the business (or business unit).
4.EVA$\rarr$NOPAT and EVA$\rarr$capital can be estimated using one of two approaches: operating approach and financing approach.These two approaches lead to equivalent estimates of EVA$\rarr$NOPAT and EVA$\rarr$capital.The approach chosen for use is a matter of personal preference.

This Question Deals with Summary Financial Performance Indicators →\rarr→ 2In What Sense Is EVA

This Question Deals with Summary Financial Performance Indicators $\rarr$
2In What Sense Is EVA