Hodak - Measuring EP/EVA

Option 2 - Exclude project results from business unit results

Managers may not have the luxury of patience. Their superiors or board members may be too remote from the operations to understand or believe reasons for short-term EP decline, or managers making the investment don't expect to be around when the project reaches fruition. In such instances, managers may feel encouraged to make strategic investments only if the short-term results of those investments are not held against them.

The short-term impact of a strategic investment can be avoided if the results of that investment are excluded from operating results by adding back the project's investment to net assets and adding back any project related income (or losses) to business unit income.

This treatment may be the only option for projects with very long lead times before income is expected to appear, e.g., for delays longer than four or five years. Beyond that, the time horizon for managers (typically in their positions for less than five years) make accountability for EP results, or for any period measure, virtually impossible. The best that investors can hope for with such lag times is project-based accountability, that is, holding management to project milestones or within a budget in the belief that, if the project is completed within budget, value creation will follow.

While this treatment leaves management neutral about the short-term results, it also leaves them without a positive incentive to trade off additional (or less) investment for additional (or less) income. Thus, exclusion of results could lead to over-investment, especially if the project began yielding deficient results versus those originally planned, possibly encouraging managers to "throw good money after bad" to remedy the situation. Furthermore, project income can become impossible to segregate from overall business unit income as time progresses. Trying to isolate project income may be like trying to keep track of water from a bucket thrown into a pool. Even if a project has discrete revenue units, it may have shared expenses or it may generate collateral revenues for other product lines that cannot be objectively isolated.