Q3) what are the concept of ROI .What is its advantage and disadvantage.

Many experts regard EVA as a concept is superior to ROI and yet in certain cases EVA does not do justice to the evaluation of investment centre. Explain this phenomenon with illustration. Explain +ve and ve feature of EVA. Ans :Rate of Return on Investment (ROI) Meaning A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio. Formula:

ROI

Profit After Tax Capital Employed

Return on investment is a very popular metric because of its versatility and simplicity. That is, if an investment does not have a positive ROI, or if there are other opportunities with a higher ROI, then the investment should be not be undertaken. Advantages: ROI allows management to assess both profitability and efficiency in using assets. Divisions of unequal size can be compared. Management is provided with information to make decisions on where to invest additional company funds. The company knows where it is getting "the most bang for its buck."

Disadvantage: If a manager is evaluated based on ROI, he or she will not invest in any project that will lower the division's ROI, even if it would increase the company's profitability.

EVA
EVA is a value-based measure that was intended to evaluate business strategies, capital projects and to maximize long-term shareholders wealth. Value that has been created or destroyed by the firm during the period can be measured by comparing profits with the cost of capital used to produce them. Mathematically, the EVA can be calculated as EVA = NOPAT (WACC X Capital Employed) Where, NOPAT means Net Operating Profit before Interest and after Tax WACC represents Weighted Average Cost of Capital.

COMPONENTS OF EVA
Net Operating Profit After Taxes NOPAT is easy to calculate. From the income statement we take the operating income and subtract taxes. Operating income is sales less cost of sales and less selling, general and administrative expenses. Net Operating Income Net Operating Income or NOI is a means of expressing pure operating results. In other words, financial results of NOI do not have the impact of financing (borrowing), investing, or accounting adjustments, which can distort a purely operational analysis. NOI is the amount of money generated exclusively from operations. Calculating Cost of Capital Many businesses dont know their true cost of capital, which means that they probably dont know if their company is increasing in value each year. There are two types of capital, borrowed and equity. The cost of borrowed capital is the interest rate charged by the bondholders and the banks. Equity capital is provided by the shareholders. An investors expected rate of return on an investment is equal to the risk free rate plus the market price for the risk that is assumed with the investment. The risk of a company can be decomposed into two parts. An investor can eliminate the first component of risk by combining the investment with a diversified portfolio. The diversifiable component of risk is referred to as non-systematic risk. The second component of risk is non-diversifiable and is called the systematic risk. It stems from general market fluctuations which reflect the relationship of the company to other companies in the market. The non-diversifiable risk creates the risk premium required by the investor. In the security markets the non-diversifiable risk is measured by a firms beta. The higher a companys non-diversifiable risk, the larger their beta. As the beta increases the investors expected rate of return also increases.

EVA is much better than RO as a controlling tool and as a performance measure 1. Steering failure in ROI Increase in RO is not necessarily good for shareholders i.e. maximizing RO can not be set as a target. (Increase in RO would be unambiguously good only in the companies where capital can be neither increased or decreased -> however we leave in a world where both operations are easily executed in almost all companies) 2. EVA is more practical and understandable than RO As an absolute and income statement -based measure EVA is quite easily explained to non-financial employees and furthermore the impacts o different day-to-day actions can be easily turned into EVA-figures since an additional $100 cost decreases EVA with $100. (RO is neither easy to explain to employees or can day-to-day actions easily be expressed in terms of ROI)

EVA vs return on investment (steering failure) Example: ROI 30%. How ROI and EVA change after an investment producing a return of 20% ?
Bg n g e in in Oea gpo p r tin r f it Cp l ine te a ita v s d Cs o c p l o t f a ita EA V I vs e t ne tmn I vs e t A ne tmn I ce s ino ea gpo n r a e p r tin r f it I ce s inc p l ine te n r a e a ita v s d 9 % 3 ,0 0 00 3 ,0 0 00 10 0 0 ,0 0 x RI O 10 0 0 ,0 0 90 ,0 0 = = 3 .0% 0 90 ,0 0 2 ,0 0 10

30 ,0 0 2 ,0 0 00

(ar t r o eun f

1 .0% 5

S itu a t io n if in ve s t m e n t d o n e R O I a nd E V A a fte r in ve s t m e n t d o n e : O p era t in g p ro fit 30,000 + 3000 = 33,000 C a p ita l in ve s t e d 1 0 0 , 0 0 0 + 2 0 ,0 0 0= 1 2 0 , 0 0 0 R O I C o s t of c a p it a l EV A 9% x 3 3 ,0 0 0120,000 = 10,800 = 10,800 22,200

27.5 %

R O I fa l l s 3 0 .0 = > 2 7 .5 % % O p e r a t i n g p r o fi t ris e s 3 0 , 0 0= 0> 3 3 , 0 0 0 E V A r i s e s 2 1 , 0 0= 0> 2 2 , 2 0 0

ROI does not take into account the increase or decrease in invested capital. Therefore it does not necessarily describe whether the profitability has decreased or improved .

ADVANTAGES AND DISADVANTAGES OF EVA

Advantages of EVA EVA is more than just performance measurement system and it is also marketed as a motivational, compensation-based management system that facilitates economic activity and accountability at all levels in the firm. Stern Stewart reports that companies that have adopted EVA have outperformed their competitors when compared on the basis of comparable market capitalization. Several advantages claimed for EVA are:

EVA eliminates economic distortions of GAAP to focus decisions on real economic results EVA provides for better assessment of decisions that affect balance sheet and income statement or tradeoffs between each through the use of the capital charge against NOPAT EVA decouples bonus plans from budgetary targets EVA covers all aspects of the business cycle EVA aligns and speeds decision making, and enhances communication and teamwork

Limitations of EVA EVA also has its critics. The biggest limitation is that the only major publiclyavailable sample evidence on the evidence of EVA adoption on firm performance is an in-house study conducted by Stern Stewart and except that there are only a number of single-firm or industry field studies.

EVA does not control for size differences across plants or divisions EVA is based on financial accounting methods that can be manipulated by managers EVA may focus on immediate results which diminishes innovation EVA provides information that is obvious but offers no solutions in much the same way as historical financial statement do. Given the emphasis of EVA on improving business-unit performance, it does not encourage collaborative relationship between business unit managers EVA although a better measure than EPS, PAT and RONW is still not a perfect measure

Q.4) Explain concept of ROI.Give +ve and ve fetures. Show calculation with Dupont analysis.

ROI
A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To

calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio. There are two ways of calculating ROI: the traditional formula and the DuPont formula. The traditional approach presents a single, static measure of a company's past performance. In contrast, the approach developed by the DuPont Corporation uses two factors, net profit margin and total asset turnover, to measure success in recognition of the fact that excessive funds tied up in assets can be just as much of a drag on profitability as excessive expenses.
Traditional Formula:
ROI = Net Profit After Taxes Total Assets

DuPont Formula:
ROI = (Net Profit Margin) x (Total Asset ROI = (Net Profit After Taxes Sales) x (Sales Total Assets) Turnover)

For example, using the traditional formula, a company with $100,000 in total assets and $18,000 in net profit after taxes would have an ROI of 18%. The DuPont formula takes the analysis one step further by factoring in sales. Using the previous example, if sales are $200,000, then the net profit margin is only 9% and the total asset turnover is 2. This still yields an ROI of 18% but provides more insight into how the company was managed and what might be changed to improve profitability. The breakdown of ROI into its two components reveals that a number of combinations of net profit margin (M) and total asset turnover (T) can produce the same return on investment. For example:
ROI 18% 18% 18% 18% = 2% x 9 = = = = M 9% 6% 3% x x x x T 2 3 6

Advantages: ROI allows management to assess both profitability and efficiency in using assets. Divisions of unequal size can be compared. Management is provided with information to make decisions on where to invest additional company funds. The company knows where it is getting "the most bang for its buck."

Disadvantage:
If a manager is evaluated based on ROI, he or she will not invest in any project that will lower the division's ROI, even if it would increase the company's profitability.