mODULE 3 ROI EVA RI 2021

Amity School Of Business
Amity School Of Business

BBA Semester 8TH
1
Return Amity School Of Business
on Investment (ROI)
• Return on investment is a popular and
easier method of measuring investment
centre performance.
• ROI is the relationship between return or
profit and investment.
• It is usually expressed in terms of
percentage.
2
ROI Amity School Of Business
The profit here refers to profit before taxes

and interest or operating profit.
profit before taxes and interest is not

influenced by extraneous factors such as
financing or taxes over which the divisional
manager does not have any control.
3
Similarly, the investment here refers to

operating assets which are available for use
in the operations
4
5
6
• Net operating investment may be in terms

of written down value or the gross value of
the fixed assets.
• The net value of the assets would depend
upon the depreciation method used.
• It would be better to use, the average
value of the fixed assets during their useful
life.
7
ROI-Problem Amity School Of Business
Consider the case of ABC Company which has a

equipment costing Rs. 1,00,000.
• The equipment has five year life and no salvage
value.
• The equipment can generate a cash return of
Rs. 50,000 per annum.
• The equipment is depreciated on a straight-line
basis.
• The company has an expectation of minimum
rate of return of 25% on investment.
8
Company ROI Computation Using Net Book Value of Asset
1 2 3 4 5
Net Book Value at Beginning of

Year (Rs. ‘000) 100 80 60 40 20
Cash Return (Rs. ‘000) 50 50 50 50 50
Less: Depreciation
Profit Before Taxes
Return on Investment%
9
• ROI using gross book value of the assets

will be ???? for all the five years since the
profit before taxes is the same during all
the years. (Profit Before Taxes/Gross Book
Value) x 100%.
10
• ROI using gross book value of the assets

will be 30% for all the five years since the
profit before taxes is the same during all
the years.
• (Profit Before Taxes/Gross Book Value) x
100%.
• = (30,000/1, 00,000) x 100 = 30%
11
• Now take average investment as book

value of the assets at the beginning of the
period plus the book value of the asset at
the end of the period divided by two
• i.e. (1,00,000 + 0) = 50,000,
• ROI on average investment will be
12
Advantages Amity School Of Business
For measuring divisional performance, ROI method has

advantages.
(i) this is generally accepted method

(ii) it is a relative and not absolute measure;
(iii) it is conceptually easy to understand and interpret; and
(iv) it provides incentive for optimum utilization of the
assets of the company concerned.
13
Economic Value Added Amity
(EVA)School Of Business
(Residual Income)
• An alternative measure of financial
performance in an investment centre
• Economic Value Added (EVA) is the
amount in rupees that remains after
deducting an "implied" interest charge
from operating income.
• The implied interest charge reflects an
opportunity cost, and is charged on the
amount of assets in each investment
centre 14
EVA Amity School Of Business
The rate of interest charge is equal to the

minimum rate on investment specified by top
management as part of the corporate
strategic plan.
15
Formula Amity School Of Business
EVA = Net operating profit after tax-(cost of

capital x economic book value of the capital
employed in the firm).
EVA = Economic book value of the capital

employed in the firm ( return on capital –
cost of capital)
16
Problem
A division has a budgeted income of Rs.10
lakhs and a budgeted investment of Rs. 60
lakhs.
average cost of capital for the firm is 12 %.
Find out the budgeted residual income ?
17
The budgeted residual income is
• Divisional Income Rs. 10 lakhs

• Interest charge 12% on Rs. 60 lakhs Rs. 7.20
• Residual income/Economic value added Rs.2.80
18
Different interest rates may be applied to

different components of investment like
Fixed assets, inventories, receivables and
cash.
19
• During the 1990s, residual income has been refined and

remained as Economic Value Added (EVA) by Stern
Steward Counseling Organization and they have
registered EVA (TM) as their trademark.
• EVA can be defined as = Conventional divisional profit ±

Accumulated adjustment – cost of capital charge on
divisional assets
20
Causes for EVAAmity School Of Business
to Increase
EVA rises when:
• 1. The rate of return on existing capital increases
because of improvement in operating performance. This
means operating profit increases without infusion of
additional capital in the business.
• 2. Additional capital is invested in projects that earn a
rate of return greater than the cost of capital.
• 3. Capital is withdrawn from activities which earn
inadequate returns.
• 4. The cost of capital is lowered by altering the financial
strategy
21
• Capital employed Rs.10,000

• Net operating profit after tax Rs. 2000
• Cost of capital 15%
• Return on capital 20 %
• EVA = 10,000 (0.20 – 0.15) = 500
22
Advantages Amity School Of Business
• Compared with ROI, EVA is more likely to

encourage goal congruence in terms of
asset acquisition and disposal decisions.
• Managers are also made aware that
capital has a cost and
• they are thus encouraged to dispose off
underutilized assets that do not generate
sufficient income to cover their cost of
capital
23

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Amity School Of Business

Amity School Of Business

The profit here refers to profit before taxes

profit before taxes and interest is not

Similarly, the investment here refers to

• Net operating investment may be in terms

Consider the case of ABC Company which has a

Company ROI Computation Using Net Book Value of Asset

Net Book Value at Beginning of

Cash Return (Rs. ‘000) 50 50 50 50 50

Profit Before Taxes

• ROI using gross book value of the assets

• ROI using gross book value of the assets

• Now take average investment as book

For measuring divisional performance, ROI method has

(i) this is generally accepted method

The rate of interest charge is equal to the

EVA = Net operating profit after tax-(cost of

EVA = Economic book value of the capital

The budgeted residual income is

• Divisional Income Rs. 10 lakhs

Different interest rates may be applied to

• During the 1990s, residual income has been refined and

• EVA can be defined as = Conventional divisional profit ±

• Capital employed Rs.10,000

• EVA = 10,000 (0.20 – 0.15) = 500

• Compared with ROI, EVA is more likely to

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