The EVA Challenge for the

Multinational Corporations

Case-Study:
METRO Group

Dr. Octavian Thor Pleter, MBA (MBS)

6th of December, 2006

Q. What is the purpose of a business?
 Q. What is the purpose of a business?

• to generate maximum profits

 Q. What is the purpose of a business?

• to survive (to exist perennially)

 Q. What is the purpose of a business?

• to generate maximum profits

contradiction

• to survive (to exist perennially)

 Q. What is the purpose of a business?

• to generate maximum profits

risk
return

• to survive (to exist perennially)

 Q. What is the purpose of a business?

• to generate maximum wealth (value) for the

shareholders
 Q. What is the purpose of a business?

• to generate maximum shareholder value

with minimum shareholder effort/sacrifice
 Q. What is the purpose of a business?

• to generate maximum profits

• to survive (to exist perennially)

• to generate maximum wealth (value) for the

shareholders

• to generate maximum shareholder value

with minimum shareholder effort/sacrifice
 Business Evaluation Key Concepts

• to generate maximum profits = GP

MARGIN, NOPAT, ROS

• to survive = BETA, RISK REPORT, CR, QR

• to generate maximum wealth (value) = ROI,

ROCE, ROA, ROE, IRR

• to generate maximum value with least

effort/sacrifice = EPS, PER, RI, EVA, MVA
 EVA = Economic Value Added
(Bennett Stewart 1991)

EVA = profit – cost of capital employed

EVA= NOPAT – WACC*Capital

NOPAT = Net Operating Profit After Taxes

WACC = Weighted Average Cost of Capital

http://www.sternstewart.com
EVA destroys the myth that equity financing comes cheap, by
introducing the opportunity cost of equity capital.

More than EPS, shareholders deserve earnings above what

they could have got elsewhere.
 EVA
TRUE:
• a useful shareholder value
creation (destruction) indicator
• more relevant to the minority
investor than ROI and EPS
• a “must” in the audit of
multinational holdings (not
groups!)
• strongly correlated with stock
prices
• a management tool in the
interest of the uncommitted
???:
• EVA ™ = the best approach to
any business evaluation
• “the financial performance
measure that comes closer than
any other to capturing the true
economic profit of an enterprise”
(Stewart)
• “EVA® is the performance
measure most directly linked to
the creation of shareholder
wealth over time.” (Stewart)
Calculation of EVA

 yearly / quarterly
 needed: Income Statement (P&LA) and Balance Sheet
 + EVA means value creation
 – EVA means value destruction

EVA based decision making:

 managers’ compensation scheme based on EVA
 restructuring / selling / closing down businesses which
persistently destroy value
 WACC

Calculation of EVA
Weighted Average Cost of Capital

Equity Cost of
Capital Debt Cost of Capital

Risk-free rate 5,00% Risk-free rate 5,00%

Market Risk Premium 8,00% Long Term Debt Risk 3,00%

13,00% 8,00%

x the industry Beta 1,60 less Tax effect (16%) -1,28%

20,80% 6,72%
Calculation of EVA

20,80% 6,72%

weighted by:

40,00
Equity Financing 60,00% Debt Financing %

WAECC 12,48% WADCC 2,69%

WACC 15,17% (WAECC+WADCC)

Calculation of EVA

NOPAT =
= Net Operating Profit After Taxes =
= Net Profit from Continuing
Operations – corresponding Income
Tax
= EBIT – Income Tax =
= EAIT + Interest
___________________
€ mil.
NOPAT = 50 – 8 (50@16%) = 42
Calculation of EVA
BALANCE SHEET

€ mil.

ASSETS LIABILITIES AND EQUITY

Fixed Assets Equity 2000

Intangible Assets 100

Tangible Assets 1900 Liabilities

Financial Assets 500 Long-Term Liabilities 1700

2500 Current Liabilities 800

Current Assets 1000 2500

3500 3500
Calculation of EVA

CE =
= Capital Employed =
= TA Total Assets – CL Current
Liabilities
(may be averaged over one year)
____________
€ mil.
CE = 3,500 – 800 = 2,700
Calculation of EVA

EVA = NOPAT – WACC × CE

_____________
€ mil.
EVA = 42 – 15.17% × 2,700 =
(367.59)
Calculation of EVA

EVA = NOPAT – WACC × CE

How to increase EVA?
• increase Sales EVA = NOPAT – WACC × CE

• reduce Costs
• minimize Income Tax
• modify equity-to-debt ratio to minimize the cost of capital
• reduce the capital employed (sell the not-so-profitable
business units, sell underused assets)
 EVA for Small and Medium Companies
(Mäkeläinen, Roztocki)

???

EVA assumes a rational shareholder with a totally

opportunistic, short-term sighted behaviour.
Small/Medium Private
Companies
Shareholders:
• stay loyal to their
investment, often
managing themselves;
• accept efforts, sacrifices
due to high barriers of exit
Large Public Corporations
Shareholders:
• switch easily to the best
investment opportunity
• avoid efforts and
sacrifices due to low
barriers of exit
Small/Medium Private Large Public Corporations
Companies

Adequate “scoring” Adequate “scoring”

models: models:
GP MARGIN, ROS, ROI, EPS, EVA, MVA
ROA
 EVA

“People want economy, and they'll pay any price to get it.”
(Lee Iaccoca)
 EVA

Q: Based on EVA, most car manufacturers should have closed

down years ago because they destroy shareholder value year
after year*). Why do we bear with them?

*) car industry shareholder value creators/destructors:

+ Porsche, Toyota
– Daimler-Chrysler, all others
– – Ford, Fiat
Source: The Economist (2005)
 EVA

EVA is useful as a financial indicator:

• relevant
• intuitive
• comparable across the whole economy
• stimulates shareholder’s trust
 EVA

EVA is less useful as a decision making tool:

• CONTROL: as any pure financial control
technique, inhibits strategic thinking
• ACCOUNTING: as any financial accounting
tool, lacks full representation of the company’s
resources
• UNWANTED SIDE EFFECTS: as any financial
accounting tool, encourages creative
accounting, with bad effects when you get
obsessed with it
 CONTROL

Q: Is the uncommitted / low involvement / short-term focused /

opportunistic shareholder the key character in the economy of
the 21st century?

STRATEGIC CONTROL (classical group of companies)

FINANCIAL CONTROL (classical holding)
 CONTROL

Q: Is the uncommitted / low involvement / short-term focused /

opportunistic shareholder the key character in the economy of
the 21st century?

STRATEGIC CONTROL (classical group of companies)

FINANCIAL CONTROL (classical holding)
ETHICAL CONTROL (a new breed: Google: “don’t be evil!”)
 ACCOUNTING

Q: Are Business RESOURCES represented in the Financial

Reports?
Q: Are Business RESOURCES represented in the Financial
Reports?

• financial resources (YES*)

• material resources (YES*)

Q: Are Business RESOURCES represented in the Financial
Reports?

• financial resources (YES*)

• material resources (YES*)

Q: Are Business RESOURCES represented in the Financial
Reports?

• financial resources (YES*)

• material resources (YES*)

Q: Are Business RESOURCES represented in the Financial
Reports?

• human resources (NO)

• information resources (NO)

• ethical / integrity resources (arguably NO)

 EVA Unwanted Side Effects

EVA = NOPAT – WACC × CE

An EVA driven corporation is:

• rather conservative with its capital
• buy-make decision is biased towards “lease”
• pushing tax avoidance
• obsessed with asset utilization
• not the ideal workplace for a happy manager
 EVA Unwanted Side Effects

EVA = NOPAT – WACC × CE

The Business Units employing more capital or generating

lower NOPAT deteriorate the aggregate EVA!

CONSEQUENCE: the EVA driven multinationals are selling

their not-so-profitable business units.
 EVA Unwanted Side Effects

EVA = NOPAT – WACC × CE

CONSEQUENCE: the EVA driven multinationals are selling

their not-so-profitable business units.

SURPRISE: the profitable business units left in the portfolio

turn less profitable than before, loosing economy of scale
WARNING: Not all your business units should be treated
equally as EVA does!

What happens if we allocate cost of capital equally among the

business units?

Example of EVA “fundamentalism”:

€ mil. A B C TOTAL
Sales 20 40 40 100
Expenses + Tax 16 32 28 76
NOPAT 4 8 12 24
Cost of Capital 6 6 6 18
EVA –2 2 6 6
Sell A:
€ mil. A B C TOTAL
Sales 0 40 40 80
Expenses + Tax 0 35 30 65
NOPAT 0 5 10 15
Cost of Capital 0 6 6 12
EVA 0 –1 4 8

Sell B:
€ mil. A B C TOTAL
Sales 0 0 40 40
Expenses + Tax 0 0 35 35
NOPAT 0 0 5 5
Cost of Capital 0 0 6 6
EVA 0 0 –1 –1
Sell C:
€ mil. A B C TOTAL
Sales 0 0 0 0
Expenses + Tax 0 0 0 0
NOPAT 0 0 0 0
Cost of Capital 0 0 0 0
EVA 0 0 0 0

Happy shareholder:
CONCLUSIONS:
 EVA is a rather short-sighted instrument for financial
control of large multinational holdings, adequate for those
in deep need of strategic steering and leadership

 EVA as a management tool could be hazardous to the

corporations’ long-term health

 in the future, a good auditor should turn his/her attention

from EVA-like fundamental financial control to a broader
scope including strategic control, risk control, and even
ethical control
I hope you enjoyed it, thanks for your attention!

(15 minutes break)

Case Study and Debate

 Case-Study:
METRO Group

Dr. Octavian Thor Pleter, MBA (MBS)

You have the financial statements of the METRO
Group. So what?

Always look for the people

behind the Financial
Statements!

You’ll never truly understand the statements if you

don’t understand these people.
 The Story

The people behind the Financial Statements

Bernd Bothe Dr. Hans-Joachim Körber

 The Story

 Vice-president in the 1990s, chosen

by President Conradi to follow him
 CEO since late 1990s until 2002,
when forced to quit due to 9/11
disaster (Metro’s shares down 60%)
 Created and implemented the Metro
global expansion strategy
Bernd Bothe
 Quadroupled sales in 1995-2000
 Advocated strategic control
 “Shareholders don’t give a damn’ on
EVA. They want global expansion”
 The Story

 Board member in the 1990s, with

support from some of the founders
 CEO since 2002, finally succeeding
in his confrontation with Bothe
 Criticized Bothe and the Metro
global expansion strategy
 “The Treasury makes more profits Dr. Hans-Joachim
than the Cash & Carry – we’d better Körber
sell the shops and go for the more
profitable financial investments”
 Introduced financial control and the
EVA-based management
 The Story

Using the Financial Statements of 2005/2004 and 2001/2000:

 Assess the evolution of the METRO Group
 Detect the effects of the EVA based management
 What should catch your eye as an auditor?
 What is your opinion about the future of METRO Group?
 Case-Study:
METRO Group

Case Closed.

Thanks, Well Done!

Dr. Octavian Thor Pleter, MBA (MBS)

octavianpleter@yahoo.com