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FRM Part II · FRM Exam Part II · Risk Capital Attribution and Risk-Adjusted Performance Measurement

Which statement best describes a limitation of using single-period EVA to reward business unit managers?

A single-period EVA can push managers toward short-term decisions and make them avoid positive-NPV projects whose early-year EVA is negative, since rewards are tied to the current period's result rather than the project's lifetime value.

  1. AIt can encourage managers to favour short-term actions and underinvest in positive-NPV projects whose early-year EVA is negativeCorrect
  2. BIt ignores the cost of equity capital entirely
  3. CIt cannot be computed for units without a market price
  4. DIt always overstates value creation when risk capital is used as the capital base

Explanation

EVA includes a capital charge, so it does not ignore the cost of capital. Because it is measured period by period, projects with negative early EVA but positive NPV may be rejected, and managers may under-invest. It does not require market prices for units, and it does not systematically overstate when risk capital is used.

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