Hodak - Measuring EP/EVA

Option 2: Proportion of EP

If complete information is available for an unconsolidated venture, the company can calculate EP for the venture consistent with the companys own EP calculation. The ventures equity income would be subtracted from the business units income. A proportional share of the ventures NOPAT and Capital would be added back to business unit income and net assets, respectively. Then, the companys proportion of the ventures after-tax interest expense must be added back to business unit income and its proportion of the ventures debt must be added back to business unit net assets. From our prior example, this adjustment is illustrated as follows:

      Income         $2.0                    Equity         $10
      A/T Interest* 1.0                  Debt               25

      NOPAT           3.0                    Capital          35

      * Equal to pre-tax interest of 6.0 less 33% tax, which equals 4.0, times 25% proportion of ownership.

EP:

      NOPAT               $3.0

      Capital                35.0

      Cost of Capital    10%

      Capital Charge    3.5

      EP                         (0.5)

The benefit of this adjustment is that it more perfectly reflects the value contribution of the venture to the business unit. If the business unit has effective managerial control over the joint venture, management may consider total consolidation of venture NOPAT and Capital into the business unit's income and net assets.

The drawback to this adjustment is the need to calculate EP and to track its proportion of income, interest expense, and net assets and to communicate these items to operating managers who may or may not feel that they have effective control of the venture.