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CMA Final · Strategic Performance Management and Business Valuation · Introduction to Performance Management

Ganga Pharma Ltd had operating profit after tax of Rs 36 crore, capital employed of Rs 200 crore and a cost of capital of 12%. Its CEO says the division is performing well because it earns a profit. Using economic value added (EVA) as the measure of value creation, what is the correct assessment?

EVA is Rs 12 crore and positive, so value is created. The capital charge is 12% of Rs 200 crore, equal to Rs 24 crore, and deducting it from the after-tax operating profit of Rs 36 crore leaves a surplus of Rs 12 crore for shareholders.

  1. AEVA is Rs 12 crore, so value is createdCorrect
  2. BEVA is Rs 24 crore, so value is created
  3. CEVA is Rs 12 crore, so value is destroyed
  4. DEVA is Rs 36 crore because cost of capital is ignored in EVA

Explanation

Capital charge = 12% x Rs 200 crore = Rs 24 crore. EVA = 36 - 24 = Rs 12 crore, which is positive, so value is created. Rs 24 crore is merely the capital charge, a common mistake of reporting the charge instead of the surplus after it. Option 4 ignores the capital charge, which EVA specifically deducts.

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