1.1 INTRODUCTIONIntroduction and origin: The aim of any professional organization is to maximize the wealth of share holders, which is measured by the returns they receive on their investment. Returns are in two parts, first is in the form of dividends and the second in the form of capital appreciation reflected in the market value of shares. But the market value of shares is influenced by a lot of factors, many of which may not be fully influenced by the management of a firm. However one factor which has a significant influence on the market value is the expectation of the shareholders regarding the return on the investment. The question then arises is which measure of corporate performance is liked to be expectation of the shareholders. Various measures like Earnings Per Share (EPS), Return On Equity (ROE), Return On Investment (ROI) and Return On Capital Employed (ROCE) have been used to evaluate the performance of the business. The problem with these performance measures is that they lack a proper bench mark for comparison. Because they ignore the minimum rate of return on investment expected by the share holders. To overcome this problem the consultancy firm Stern Stewart came up with a performance measure that takes into account the minimum returns required by the shareholders. They called this measure the Economic Value Addition (EVA) Definition & calculation of EVA : EVA is the return a firm earns in excess of the minimum required by the investors. As for the formal definition, EVA is calculated using the following formula. EVA = NOPAT (WACC ^ CE) Where, NOPAT = Net operating profit after tax. WACC = Weighted Average cost of capital

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CE = Capital employed Weighted average cost of capital is the weighted average of the cost of debt cost of equity and cost of preference capital with weightages equivalent to the proportion of each in the total capital. NOPAT is measured from the income statement by adding back interest payments and subtracting and adding non operating income and expenses respectively to the net profit figure. Capital employed consists of adjusted equity share holders fund, all interest bearing obligations and preference capital. Improving EVA: Following are the ways in which the EVA can be improved Increasing NOPAT with the same amount of capital Reducing the capital employed without affecting the earnings ie discarding the unproductive assets. Investing in those projects that earn a return greater than the cost of capital. Reducing the cost of capital,, which means employing more debt, as debt is cheaper than equity or preference capital. EVA Barometer for Better Management : EVA forces the management to expressly recognize its cost of equity and to take that cost into account in all its decision. It measures the amount of value a firm creates during a definite period through operating decisions that improve margins, efficiently utilize its production facilities, improve management of working capital and redeploy under utilized assets. Thus EVA can be used to hold management accountable for all economic outlays whether they appear in the income statement, on the balance sheet or in the foot notes to financial statement.

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Draw backs of EVA: It ignores inflation. So it is biased against new assets. Whenever a new investment is made capital charge is on the full cost initially, so EVA figure is low. But as the depreciation is written off the capital charge decreases and hence EVA goes up. Since EVA is measured in Rupee terms it is biased in favour of large, low return businesses. Large businesses that have returns only slightly above the cost of capital can have higher EVA than smaller businesses that earn returns much higher than the costs. Short term EVA can be improved by reducing assets faster than the earnings and if this is pursued for long it can lead to problems in the longer run when new improvements to the asset base are made. Corporate facts : According to the Economic Times Research Bureau, the aggregate EVA of the 100 large sample companies works out to just Rs. 95 crore in excess of what the same capital could generate had it been invested at 13 % rate of interest. Any system will bear fruits only when it is well implemented and has the support of all the parties concerned and EVA is no exception to this rule. Moreover as with any other system EVA too has limitations but it still stands as an improvement over measures like ROI and ROE and if implemented will be taking the limitations into account will yield better results.

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1.2 INDUSTRY PROFILEINDIAN POWER SECTOR The power sector has registered significant progress since the process of planned development of the economy began in 1950. Hydro -power and coal based thermal power have been the main sources of generating electricity. Nuclear power development is at slower pace, which was introduced, in late sixties. The concept of operating power systems on a regional basis crossing the political boundaries of states was introduced in the early sixties. In spite of the overall development that has taken place, the power supply industry has been under constant pressure to bridge the gap between supply and demand. Growth of Indian power sector Power development is the key to the economic development. The power Sector has been receiving adequate priority ever since the process of planned development began in 1950. The Power Sector has been getting 18-20% of the total Public Sector outlay in initial plan periods. Remarkable growth and progress have led to extensive use of electricity in all the sectors of economy in the successive five years plans. Over the years (since 1950) the installed capacity of Power Plants (Utilities) has increased to 89090 MW (31.3.98) from meagre 1713 MW in 1950, registering a 52d fold increase in 48 years. Similarly, the electricity generation increased from about 5.1 billion units to 420 Billion units 82 fold increase. The per capita consumption of electricity in the country also increased from 15 kWh in 1950 to about 338 kWh in 1997-98, which is about 23 times. In the field of Rural Electrification and pump set energisation, country has made a tremendous progress. About 85% of the villages have been electrified except farflung areas in North Eastern states, where it is difficult to extend the grid supply. Structure of power supply industry In December 1950 about 63% of the installed capacity in the Utilities was in the private sector and about 37% was in the public sector. The Industrial Policy Resolution of 1956 envisaged the generation, transmission and distribution of power almost exclusively in the public sector. As a

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result of this Resolution and facilitated by the Electricity (Supply) Act, 1948, the electricity industry developed rapidly in the State Sector. In the Constitution of India "Electricity" is a subject that falls within the concurrent jurisdiction of the Centre and the States. The Electricity (Supply) Act, 1948, provides an elaborate institutional frame work and financing norms of the performance of the electricity industry in the country. The Act envisaged creation of State Electricity Boards (SEBs) for planning and implementing the power development programmes in their respective States. The Act also provided for creation of central generation companies for setting up and operating generating facilities in the Central Sector. The Central Electricity Authority constituted under the Act is responsible for power planning at the national level. In addition the Electricity (Supply) Act also allowed from the beginning the private licensees to distribute and/or generate electricity in the specified areas designated by the concerned State Government/SEB. During the post independence period, the various States played a predominant role in the power development. Most of the States have established State Electricity Boards. In some of these States separate corporations have also been established to install and operate generation facilities. In the rest of the smaller States and UTs the power systems are managed and operated by the respective electricity departments. In a few States private licencees are also operating in certain urban areas. From, the Fifth Plan onwards i.e. 1974-79, the Government of India got itself involved in a big way in the generation and bulk transmission of power to supplement the efforts at the State level and took upon itself the responsibility of setting up large power projects to develop the coal and hydroelectric resources in the country as a supplementary effort in meeting the countrys power requirements. The National thermal Power Corporation (NTPC) and National Hydroelectric Power Corporation (NHPC) were set up for these purposes in 1975. North-Eastern Electric Power Corporation (NEEPCO) was set up in 1976 to implement the regional power projects in the North-East. Subsequently two more power generation corporations were set up in 1988 viz. Tehri Hydro Development Corporation (THDC) and Nathpa Jhakri Power Corporation (NJPC). To construct, operate and maintain the inter-State and interregional

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transmission systems the National Power Transmission Corporation (NPTC) was set up in 1989. The corporation was renamed as POWER GRID in 1992. Current problem of power sector The most important cause of the problems being faced in the power sector is the irrational and unremunerative tariff structure. Although the tariff is fixed and realized by SEBs, the State Governments have constantly interfered in tariff setting without subsidizing SEBs for the losses arising out of State Governments desire to provide power at concessional rates to certain sectors, especially agriculture. Power Supply to agriculture and domestic consumers is heavily subsidized. Only a part of this subsidy is recovered by SEBs through cross subsidization of tariff from commercial and industrial consumers. The SEBs, in the process, have been incurring heavy losses. If the SEBs were to continue to operate on the same lines, their internal resources generation during the next ten years will be negative, being of the order of Rs.(-) 77,000 crore. This raises serious doubts about the ability of the States to contribute their share to capacity addition during the Ninth Plan and thereafter. This highlights the importance of initiating power sector reforms at the earliest and the need for tariff rationalization. Power sector reforms The Orissa Government was the first to introduce major reforms in power sector through enactment of Orissa Reforms Act, 1995. Under this Act, Orissa Generating Company, Orissa Grid Company and Orissa Electricity Regulatory Commission have been formed. Similarly, the Haryana Government has also initiated reform programme by unbundling the State Electricity Board into separate companies and Haryana Electricity Regulatory Commission has already been constituted. With a view to improve the functioning of State Electricity Boards, the Government promulgated the State Electricity Regulatory Commission Act for establishment of Central Electricity Regulatory Commission at the national level and State Electricity Regulatory Commission in the States for rationalisation of tariff and the matters related thereto. Subsequent to the enactment of ERC Act, 1998 more and more States are coming up with an action plan to undertake the reform programmes. In this respect, Governments of Uttar Pradesh, Rajasthan,6

Madhya Pradesh, Goa, Karnataka and Maharashtra have referred their proposals for setting up independent regulatory mechanism in their States. The Electricity (Amendment) Act 1998 was passed with a view to make transmission as a separate activity for inviting greater participation in investment from public and private sectors. The participation by private sector in the area of transmission is proposed to be limited to construction and maintenance of transmission lines for operation under the supervision and control of Central Transmission Utility (CTU)/State Transmission Utility (STU). On selection of the private company, the CTU/STU would recommend to the CERC/SERC for issue of transmission license to the private company. In this regard, the Government of Karnataka is the first to invite private sector participation in transmission by setting up joint-venture company. Other States are also in the process of introducing the reforms in the transmission sector. In view of the urgent need to reduce transmission and distribution losses and to ensure availability of reliable power supply to the consumers reforms in the distribution sectors are also been considered by establishing distribution companies in different regions of the State. The entry of private investors will be encouraged wherever feasible and it is proposed to carry out these reforms in a phased manner. The Governments of Orissa and Haryana have already initiated reforms in the distribution sector by setting up distribution companies for each zone within their States. With these efforts, it is expected that the performance of power sector will improve because of rationalisation of tariff structures of SEBs and adequate investment for transmission and distribution sector.

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1.3

COMPANY PROFILE

BHEL is the largest engineering and manufacturing enterprise in India in the energyrelated/infrastructure sector, today. BHEL was established more than 40 years ago, ushering in the indigenous Heavy Electrical Equipment industry in India - a dream that has been more than realized with a well-recognized track record of performance. The company has been earning profits continuously since 1971-72 and paying dividends since 1976-77. BHEL manufactures over 180 products under 30 major product groups and caters to core sectors of the Indian Economy viz., Power Generation & Transmission, Industry, Transportation, Telecommunication, Renewable Energy, etc. The wide network of BHEL's 14 manufacturing divisions, four Power Sector regional centres, over 100 project sites, eight service centres and 18 regional offices, enables the Company to promptly serve its customers and provide them with suitable products, systems and services -- efficiently and at competitive prices. The high level of quality & reliability of its products is due to the emphasis on design, engineering and manufacturing to international standards by acquiring and adapting some of the best technologies from leading companies in the world, together with technologies developed in its own R&D centres.

BHEL has acquired certifications to Quality Management Systems (ISO 9001), Environmental Management Systems (ISO 14001) and Occupational Health & Safety Management Systems (OHSAS 18001) and is also well on its journey towards Total Quality Management.

BHEL has Installed equipment for over 90,000 MW of power generation -- for Utilities, Captive andIndustrial users.

BHEL has Supplied over 2,25,000 MVA transformer capacity and other equipment operating in Transmission & Distribution network up to 400 kV (AC & DC).

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BHEL has Supplied over 25,000 Motors with Drive Control System to Power projects, Petrochemicals, Refineries, Steel, Aluminum, Fertilizer, Cement plants, etc.

BHEL has Supplied Traction electrics and AC/DC locos to power over 12,000 kms Railway network. BHEL has Supplied over one million Valves to Power Plants and other Industries. BHEL's operations are organized around three business sectors, namely Power, Industry including Transmission, Transportation, Telecommunication & Renewable Energy - and Overseas Business. This enables BHEL to have a strong customer orientation, to be sensitive to his needs and respond quickly to the changes in the market. BHEL's vision is to become a world-class engineering enterprise, committed to enhancing stakeholder value. The company is striving to give shape to its aspirations and fulfill the expectations of the country to become a global player. The greatest strength of BHEL is its highly skilled and committed 42,600 employees. Every employee is given an equal opportunity to develop himself and grow in his career. Continuous training and retraining, career planning, a positive work culture and participative style of management ? all these have engendered development of a committed and motivated workforce setting new benchmarks in terms of productivity, quality and responsiveness.

BHEL ACHIEVEMENTS:1. Minister for Heavy Industries and Public Enterprises, Shri Manohar Joshi laid a foundation stone on July 14, 2000 for a deinking Plant in Hindustan Newsprint Ltd., Kottayam, Kerala at a cost of Rs.52.20 cr. This would improve the financial health of the company and reduce dependence on forest resources. 2. A turnaround plan for HMT Ltd. was approved by the Govt. in July, 2000. The major elements of financial and organisational restructuring include fresh infusion to the extent of Rs.395 crs. by Govt., formation of subsidiaries for machine tools & Watch business groups, closing of 5 unviable units and offer of VRS to employees.9

3. An Industrial Show was organised in Rajkot sponsored by the Ministry of Heavy Industries & Public Enterprises with the aim of increasing co-operation in heavy and small scale industries. Some of the major PSEs of DHI participated in the show. 4. The management of Lagan Jute Machinery Company Limited (LJMC), a subsidiary of Bharat Bhari Udyog Nigam Limited (BBUNL) has been handed over to M/s.Murlidhar Ratanlal Exports Limited (MREL) ( on 4.7.2000) by way of transfer of 6330 shares of LJMC in favour of MREL. 5. In some of the sick PSEs considered unviable by the BIFR/Expert Agency, Govt. have introduced a Voluntary Separation Scheme (VSS) providing benefits of VRS as a safety net to the employees of the PSEs facing the prospects of closure. VSS provides benefit of ex-gratia under VRS which is much higher than the compensation under the ID Act, 1947. 6. Govt. approved financial restructuring and a package of assistance for Hindustan Cables Ltd, which was implemented from 1.4.1999. The company achieved highest ever production of Rs.784 cr. in 1999-2000 against a production of Rs.217 cr. in 1998-99. 7. Maruti Udyog Ltd. launched three new models namely Baleno Altura, Alto-LX and AltoVX. 8. BHEL registered a substantial jump in the physical export order booking of Rs.703 cr. in 1999-2000 against a booking of Rs.69 crs. in 1998-1999. In the current year 2000-2001 also the company has bagged orders of Rs.650 crs. already (upto Nov. 2000) in the international business segment. 9. Bharat Heavy Electricals Limited (BHEL) bagged the following major orders:i. Two orders worth Rs.100 cr. and Rs.75 cr. from Indian Oil Corporation Limited (IOC), envisaging manufacture, supply, erection and commissioning of 30 MW & 20 MW Gasbased cogeneration power plant respectively, for their Panipat Refinery in Haryana and Barauni Refinery in Bihar. An order worth Rs.25 cr. against stiff international competition from Tehri Hydro Development Corporation (THDC) envisaging complete design, manufacture, testing, erection and commissioning of 4 Nos. 306 MVA, 15.75 MV/400 KV three-phase Generator Transformers for their 1000 MW Tehri Hydro Project in Uttar Pradesh. An Asian Development Bank (ADB) funded order from Arunachalam Sugar Mills Limited for 4 MW Steam Turbine-Generator (STG) for their Cogeneration Power Plant at Thiruvannamalai in Tamil Nadu. Setting up of Frame 9 Gas Turbine based Power Plant on turnkey basis at Baghabari, Bangaladesh from the Bangladesh Power Development Board, Government of Bangladesh, valued at Rs.106 crore.

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An order worth Rs.250 cr., against stiff International Competition, from NALCO for its captive power plant at Angul in Koraput District of Orissa. An order valued at Rs.810 crores from Delhi Vidyut Board for setting up an environment friendly, 330 MW, gas based power project in Delhi, to be commissioned in 30 months time. Two largest ever export orders cumulatively valued at Rs.870 Crores for manaufacture and supply of large size Gas Turbine Generating Units to Government of Iraq under the United Nations "Oil for Food" program. These orders are of special significance, as they envisage the highest rating, 159 MW, Power Plant equipment ever exported from India. Eco-friendly Advance Class Gas Turbine for a 95 MW Perungulam Combined Cycle Power Plant (CCPP) of Tamil Nadu Electricity Board (TNEB) valued at Rs.295 crores. A turnkey order from Indian Oil Corporation (IOC) for setting up an energy efficient & environment friendly 20 MW co-generation power plant at Digboi Refinery Complex in Assam. An order for a state-of-the-art Vessel Traffic Management System (VTMS) from the New Mangalore Port Trust. The order was won by consortium of BHEL with Japan Radio Company. With this order, BHEL marks its entry into the Port Automation business areas. An order worth Rs.365 crore from Karnataka Power Corporation Limited (KPCL) for setting up 210 MW unit at Raichur thermal power station with synchronization targeted in a period of 28 months, thereby setting a benchmark in schedule for commissioning of new projects in the country. Order for supply of 11 numbers of flame proof motors upto 900 KW capacity ratings from Ingersoll Dresser Pumps (IDP), UK. First ever export order an Independent Power Project (IPP) in Sri Lanka for manufacture and supply of Gas Turbine generating equipment (124 MW ISO rating) along with associated auxilliaries and spares, valued at Rs.131 cr. Largest ever overseas turnkey substation contract (330KV) valued at Rs.68 crore, for setting up of a new substation at Lusaka West besides rehabilitation of 11 existing 330 KV & 132 KV class substations, located in different parts of Zambia, being funded by the World Bank. An order for the design, manufacture, supply and testing of one number Hydro Turbine (Kaplan type) of 15 MW for unit 4 of Kurichu Hydro Electric Project (HEP) in Bhutan. An order for Steam Generators from Hindalco Industries Limited (Hindalco), valued at Rs.125 crore for enhancing the capacity of Hindalcos captive power plant at Renusagar in Uttar Pradesh. A 24 MW Steam Turbine Generator (STG) set by Rama Newsprint and Papers Limited (RNPL) for their steam turbine based cogeneration power plant at Surat in Gujarat.

10. Some other achievements of BHEL are as under : i. ii. Achieved a milestone by synchronising the second Unit of 250 MW in a record time of 20.5 months at Suratgarh Thermal Power Station (Stage I) in Rajasthan. An employee of BHELs Seamless Steal Tube Plant,.Tiruchirapalli, won the coveted Prime Ministers Shram Bhushan Award.

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Won the All India Trophy for Top Exporters, in the cataegory of Engineering Consultancy, Technical know-how & other Engineering Services Exporters, for the year 1998-99 for outstanding export performance. Bangalore plant became the first electronic equipment manufacturing unit to receive the coveted ISO-14001 certification of Det Norske Veritas (DNV). Amongst public and private sector companies in the country, BHEL has been adjudged the best organisation, for honest and prompt payment of customs duties. For the second consecutive years, since its inception in 1998-99, the prestigious Samman Patra 19992000 instituted by Ministry of Finance has been awarded to the Company for their unblemished track record with Airport Customs in terms of payment of Custom Duties. Employees of BHEL contributed a sum of Rupees One Crore to the Prime Ministers National Relief Fund. A cheque to this effect was presented by Shri K.G.Ramachandran, CMD, BHEL, to Shri Manohar Joshi, Union Minister for Heavy Industries and Public Enterpriese in New Delhi on 27th September,2000. BHEL has become the first company in the country capable of offering indigenously developed Ceramic Disc Insulators for + 500 KV High Voltage Direct Current (HVDC) applications. BHEL has achieved yet another landmark in the high-tech area of High Voltage Direct Current (HVDC) technology, with the commissioning of the 200 MW, 200 KV National HVDC project (Stage-II). This project has linked the 196 km. DC transmission line between Barsoor in Chhatisgarh and Lower Sileru in Andhra Pradesh. With this, India has joined a select band of advanced countries in the world capable of executing stateof-the-art HVDC projects. The project has been jointly funded by the Department of Heavy Industry, Ministries of Power & Information Technology, BHEL and the two utilities APSEB and MPEB. BHEL successfully commissioned 600 MW Ranjit Sagar Hydro Electric Project (HEC) in Punjab which is expected to ease the power situation in the power deficit State of Pubjab and cater to the power requirements of Himachal Pradesh and Jammu & Kashmir. BHEL successfully executed an export order for specially designed valves for the Petroleum Industry in Taiwan. These special purpose valves designed and developed indigenously have been exported to Taiwan for the first time in a tight schedule of just 3 months. Among public and private sector companies, BHEL bagged the highest award of its kind in the country from the Indian Value Engineering Society for adopting Value Management as an organised corporate activity. BHEL has entered into Technical Collaboration with MAX Control Systems Inc. USA, one of the world leaders in the field, for the manufacture of new generation Distributed Control Systems called MAX 1000+Plus. This system offers extremely fast response time resulting in higher efficiency, reliability, low operating costs and safer plant operation. BHEL won prestigious award namely "Golden Peacock National Quality Award 1999" instituted by the Institute of Directors (IOD) for achieving excellence in quality conforming to global standards.12

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12 National Safety Awards have been won by BHELs plants located at Bhopal, Hyderabad, Bangalore, Ranipet and Jagdishpur for outstanding achievements in terms of highest accident free period and lowest accident frequency rate. The awards were presented by Dr.Satyanarayan Jatiya, Union Minister of Labour on 17th September, 2000.

11. Braithwaite, Burn & Jessop (BBJ) bagged following major orders during the year : i. ii. Order for construction of Fourth Krishna Bridge near Vijayawada valued at Rs.19.86 cr. Order for construction of 3 major bridges under North Frontier Railway in Siliguri Bongaigaon Gauge Conversion Bridge against stiff competition valued at Rs.13.42 cr.

12. BBJ also diversified into marine related activity and procured a dredging order valuing Rs.9 cr. from West Bengal Fisheries Corpn. Ltd. 13. Salem Works of Burn Standard Co.Ltd. (BSCL) obtained ISO-9002 accredition during the year for its Magnesia production activities. 14. Ministry of Labour, the Appropriate Authority, have granted permission for closure of Rehabilitation Industries Corporation Limited (RIC) and Weighbird India Limited (WIL) in pursuance of the Government decision to close down six sick and unviable PSEs. Action for closure of other sick PSEs is under process. 15. Machine Tools Division of HMT introduced a no. of new products like Cylindrical Grinder PCG 130 APG, Drill Tap Centre DT40, Turning Centre Stallian 100, Vertical Machining Centre VCM 400 and VMC 800S. 16. As many as 15 new models were added by HMT for Mechanical Watches and 99 new models for Quartz Watches. 17. HMT launched two new models of Tractors. Model 7511, a heavy duty tractor for dry land cultivation and Model 3522 DX for ploughing and haulage work. 18. HMT implemented Entrepreneur and Technical Development Centre (ETDC) at Dakar, Senegal under contract from Ministry of External Affairs, Government of India. The scope of Project covered supplies and installation of machines and equipment, civil and Electrical and deputation of Experts for imparting on-the-job training. 19. HMT was associated with Govt. of India funded contract for setting up Tool Shop Extension Project in Nepal. The company has also secured an order for setting up a tool room project in Turkmenistan.

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20. Scooters India Ltd. (SIL) upgraded its model Vikram 750D which was type approved to meet the pollution norms. Another model 410D has been re-designed and type approved meeting pollution norms was introduced as Vikram 450D. 21. Engineering Projects (India) Limited (EPI) bagged following major orders : i. order worth Rs.12 cr. which envisages construction of Rain Water (RW) Reservoir, RW Pump House, Civil work Forebay and pump house and other allied works, from National Thermal Power Corporation Limited (NTPC) for their Suratgarh Thermal Power Station (STPS), suratgarh, Rajasthan, two projects Kothagudem Collieries, Andhra Pradesh and Gangapur Dam, Nashik Valuing Rs.32.73 crs. for carrying out various civil construction works. Sardar Sarovar Canal based Drinking Water Project for supply of water to Bhavnagar, District Gujarat, valued at Rs.61.85 cr. Execution of Zero Flaring facilities at Gandhar, Gujarat, valued at Rs.18.45 cr. Three projects valuing Rs.29.19 crores for construction of residential staff quarters at Juhu Aerodrome at Mumbai for Pawan Hans Helicopters Limited (Rs.16.81 crores), Turnkey contract for laying Docklines at Paradeep (Orissa) for IOC (Rs.12.09 crores) and Project Management Consultancy for development of industrial area on GT Road for Greater Noida Authority (Rs.0.29 crores).

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22. Prime Ministers MOU Award-Merit Certificate was awarded to EPI for Excellence in the Achievement of MOU targets for the year 1998-99. EPI achieved the distinction of being amongst the top ten MOU signing companies. 23. Instrumentation Limited have bagged an order for Renovation & modernisation of Santaldih Power Plant in West Bengal at a cost of over Rs.13 crores. 24. Hindustan Paper Corporation (HPC) has been given the CAPEXIL award for its outstanding export performance in 1999-2000 when it exported a total of 12147 tonnes of paper valued at about Rs.27 crs. to Bangladesh, Sri Lanka, Egypt and Mynmar. 25. Amongst public and private sector companies in the country, BHEL won the maximum number of Vishwarkarma Rashtriya Puraskar for the years 1997 and 1998. During this period, seven National safety awards were also bagged by the company.

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PRODUCT PROFILEEstablished in the late 50s, Bharat Heavy Electricals Limited (BHEL) is, today, a name to reckon with in the industrial world. It is the largest engineering and manufacturing enterprise of its kind in India and one of the leading international companies in the power field. BHEL offers over 180 products and provides systems and services to meet the needs of core sectors like: power, transmission, industry, transportation, oil & gas, non-conventional energy sources and telecommunication. A wide-spread network comprising 14 manufacturing divisions, 8 service centres, 4 power sector regional centres, 18 regional offices, besides a large number of project sites spread all over India and abroad, enables BHEL to be close to its customers and cater to their specialised needs with total solutions - efficiently and economically. An ISO 9000 certification has given the company international recognition for its commitment towards quality. With an export presence in more than 60 countries, BHEL is truly Indias industrial Ambassador to the world. PRODUCT RANGE This list is intended as a general guide and does not represent all of BHEL's products and systems. THERMAL POWER PLANTS Steam turbines and generators of up to 500MW capacity for utility and combined-cycle applications; capability to manufacture steam turbines with super critical steam cycle parameters and matching generator up to 1000 MW unit size. Steam turbines for CPP applications; capability to manufacture condensing, extraction, back pressure, injection or any combination of these types. GAS BASED POWER PLANTS Gas turbines of up to 260MW (ISO) rating. Gas turbine based co-generation and combined-cycle systems for industry and utility applications.

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HYDRO POWER PLANTS Custom-built conventional hydro turbines of Kaplan, Francis and Pelton types with matching generators, pump turbines with matching motor-generators. Mini/micro hydro sets. Spherical, butterfly and rotary valves and auxiliaries for hydro station

DG POWER PLANTS HSD, LDO, FO, LSHS, natural-gas/biogas based diesel power plants, unit rating up to 20MW and voltage up to 11kV, for emergency, peaking as well as base load operations on turnkey basis. INDUSTRIAL SETS Industrial turbo-sets of ratings from 1.5 to 120MW. Gas turbines land matching generators ranging from 3 to 260MW (ISO) rating. Industrial stream turbines and gas turbines for drive applications and co-generation applications. BOILERS Steam generators for utilities, ranging from 30 to 500MW capacity, using coal, lignite, oil, natural gas or a combination of these fuels: capability to manufacture boilers with super critical parameters up to 1000 MW unit size. Steam generators for industrial applications, ranging from 40 to 450t/hour capacity using coal, natural gas, industrial gases, biomass, lignite, oil, bagasse or a combination of these fuels. Pulverized fuel fired boilers. Stoker boilers. Atmospheric fluidized bed combustion boilers. Circulating fluidized bed combustion boilers.

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Waste heat recovery boilers. Chemical recovery boilers for paper industry, ranging from capacity of 100 to 1000 t/day of dry solids. Pressure vessels.

BOILER AUXILIARIES Fan

Axial reaction fans of single stage and double stage for clean air application, with capacity ranging from 25 to 800m3/s and pressure ranging from 120 to 1,480 m of gas column.

Axial impulse fans for both clean air and flue gas applications, with capacity ranging from 7 to 600m3/s and pressure up to 700 m of gas column. Single and double-suction radial fans for clean air and dust-laden hot gases applications up to 400oC, with capacity ranging from 4 to 600m3/s and pressure ranging from 150 to 1,800 m of gas column.

Air-Pre-heaters Ljungstrom rotary regenerative air-pre-heaters for boiler and process furnaces. Large regenerative air-preheaters for utilities of capacity up to 1000 MW.

Gravimetric Feeders Pulverizes Bowl mills of slow and medium speed of capacity up to 100 t/hour. Tube mills for pulverizing low-grade coal with high-ash content.

Pulse Jet and Reverse Air Type Fabric Filters (Bag Filters) Electrostatic Precipitators

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Electrostatic precipitators of any capacity with efficiency up to 99.9% for utility and industrial applications.

Mechanical Separators Soot Blowers Long retractable soot blowers (travel up to 12.2m), wall deslaggers, rotary blowers and temperature probes and related control panels operating on pneumatic, electric or manual mode. Swivel arm type soot blowers for regenerative air-preheaters.

Valves High-pressure and low-pressure bypass valves for utilities. High and medium-pressure valves, cast and forged steel valves of gate, globe, non-return (swing-check and piston lift-check) types for steam, oil and gas duties up to 600 mm diameter, 250 kg/cm2 pressure and 540oC temperature. High-capacity safety valves and automatic electrical operated pressure relief valves for set pressure up to 200 kg/cm2 and temperature up to 550oC. Safety relief valves for applications in power, process and other industries for set pressure up to 175 kg/cm2 and temperature up to 565oC. Piping Systems, Constant Load Hangers, Clamp and Hanger components, variable Spring hangers for power stations upto 850 MW capacities, combined cycle plants, industrial boilers and process industries.

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HEAT EXCHANGERS AND PRESSURE VESSELS CS/AS/SS/Nonferrous shell and tube heat exchangers and pressure vessels. Air-cooled heat exchangers. Surface condensers. Steam jet air ejectors. Columns. Reactors, drums. LPG/propane storage bullets. LPG/propane store mounded vessels. Feed water heaters.

POWER DEVICES High power capacity silicon diodes, thyristor power devices and solar photovoltaic cells.

TRANSPORTATION EQUIPMENT AC Electric locomotive AC-DC Dual Voltage Electric locomotive. Diesel-Electric Shunting locomotive Diesel Hydraulic Shunting locomotive OHE Recording cum Test Car. Electric Traction Equipment (for diesel/electric locos electric multiple units, diesel multiple units and urban transportation systems). Traction motors. Transformers smoothing reactors. Traction generators/alternators. Rectifiers. Bogies.

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Vacuum circuit breakers. Auxiliary machines. Microprocessor-based electronic control equipment. Power converter/inverter. Static inverter for auxiliary supply. Loco control resistances i.e. field diverters, dynamic braking resisters and inductive shunts. Traction control gear.

OIL FIELD EQUIPMENT Oil Rigs: A variety of on-shore rigs, work-over rigs, mobile rigs, heli-rigs, desert rigs for drilling up to depths of 9,000 m, completer with matching draw-works and hoisting equipment including: Mast and substructure; Rotating equipment; Mud system including pumps; Power packs and rig electrics; Rig instrumentation; Rig utilities and accessories. Well Heads and Christmas Trees/Sub Sea Equipment Well Head and X-Mas Trees for working pressures up to 10,000 psi. Choke and kill manifolds. Mud valves. Full bore valves. Block valves. Mudline suspension system. Casing support system. Sub sea Well Heads.

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1.4 NEED FOR THE STUDY

The implementation of complete EVA based financial management gives managers superior information and superior motivation to make decisions that will create the greatest shareholders wealth in any publically owned or private enterprise

EVAs biggest selling point is its relative simplicity. EVA is really just an alternate way of viewing corporate performances. It can readily be broken down to the level of a division, a factory store or even the product line. If you had to rely on only one single performance number, economic profit is probably the best because it contains so much information : economic profit incorporates balance sheet data into an adjusted income statement metric

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1.5 OBJECTIVES OF THE STUDYPRIMARY OBJECTIVETo measure the performance of an enterprise through EVA technique.

SECONDARY OBJECTIVETo choose a strategy that results in the maximum economic addition of shareholder value. To study the importance of EVA in enhancing the pay-for-performance attitude in the organization. To measure the true economic value of an enterprise that accounting omits.

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1.6 SCOPE OF THE STUDY If you had to rely on only one single performance number, economic profit is probably the best because it contains so much information (mathematicians would call it elegant) : economic profit incorporates balance sheet data into an adjusted income statement metric. Economic profit works best for companies whose tangible asset (assets on the balance sheet) correlate with the market value of assets as is often the case with mature industrial companies. It is a residual performance metric, it conveniently summarizes into a single statistic the value created and beyond all financial obligations. As an operational metric, it helps managers clarify how they create value. Generally, they do it either by investing additional capital that produces returns above weighted average cost of capital , by reducing capital employed in a business, by improving returns by growing revenues or reducing expenses or by reducing the cost of capital.

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1.7 LIMITATIONS OF THE STUDY

Although some proponents argue economic profit is all you need, it is very risky to depend on an single metric. The companies least suited for economic profit are high growth, new economy and hightechnology companies, for whom assets are off balance sheet or intangible. EVA discourages big investments because the capital charge depresses EVA. This may be evened out due to depreciation charges over the useful life of the asset, thereby reducing the average capital employed. Unless fully loaded and all cash adjustments are made, economic profit can be subject to accrual distortions .For example , because net operating profit after taxes is after depreciation and amortization, a company that does not reinvest capital to maintain its plant and equipment can improve its accrual bottom line simply by virtue of the declining D&A line. This sort of attempt at boosting economic profit is known as harvesting the assets.

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2.1 REVIEW OF LITERATUREIntroduction The aim of any organization is to maximize the wealth of the shareholder, who own the organization and expect good long-term yield on their investment. This goal has often been ignored or at least misinterpreted. Earnings per share and Return on investment are used as the most important performance measures, although they do not theoretically correlate with the shareholder value creation very well. Stern Stewart & Co. pioneered the development of Economic Value Added (EVA) framework, which offers a consistent approach to setting goals and measuring performance, communicating with investors, evaluating strategies and allocating capital. EVA as a value based performance metric seeks to measure the periodic performance in terms of change in value. Maximizing EVA means the same as maximizing long-term yield on shareholders investment. It is the measure that captures the true economic profit of the organization. Economic Value Added Defined Economic Value Added (EVA) may be defined as the net operating profits after tax minus an appropriate charge for the opportunity cost of all capital invested in an enterprise. Thus EVA = Net Operating Profit after tax Weighted Average Cost of Capital Weighted average cost of capital is defined as the cost of equity share capital plus the post tax cost of debt multiplied by the debt equity ratio. Cost of equity capital is the opportunity return from an investment with same risk as the company has. Cost of equity is usually defined with Capital asset pricing model (CAPM). The estimation of cost of debt is naturally more straightforward, since its cost is explicit. Cost of debt includes also the tax shield due to tax allowance on interest expenses. EVA can be rewritten as EVA = (ROI WACC) x CAPITAL EMPLOYED EVA captures the fact that equity should earn at least the return that is commensurate to the risk that the investor takes. In other words equity capital has to earn at least same return as similarly risky investments at equity markets. If that is not the case, then there is no real profit made and actually the company operates at a loss from the viewpoint of shareholders. On the other hand if

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EVA is zero, this should be treated as a sufficient achievement because the shareholders have earned a return that compensates the risk Market Value Added Defined A return greater than the cost of capital adds to the value of the organization. Market Value Added for listed companies have been defined as the difference between the companys market and book value. In other words if the total market value of a company is more than the amount

of capital invested in it, the company has managed to create shareholder value. If the case is opposite, the market value is less than capital invested the company has destroyed shareholder value. Market Value Added = Companys total Market Value - Capital invested And with simplifying assumption that market and book value of debt are equal, this is the same as:

Market Value Added = Market Value of Equity - Book Value of Equity

Book value of equity refers to all equity equivalent items like reserves, retained earnings and provisions. In other words, in this context, all the items that are not debt (interest bearing or non-interest bearing) are classified as equity. Thus market value added tells us how much has been added or reduced from the shareholders investment. If a companys rate of return exceeds its cost of capital, the company will have a positive MVA and will sell on the stock markets with premium compared to the original capital. On the other hand, companies that have rate of return smaller than their cost of capital sell with discount compared to the original capital invested in company. Thus whether a company has positive or negative MVA depends on the level of rate of return compared to the cost of capital. All this applies also to EVA. Thus positive EVA means also positive MVA and vice versa.

Market Value Added = Present value of all future EVA

This relationship between EVA and MVA has its implications on valuation. By replacing the market value added with the present value of future EVA we can obtain the value of the company as:

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Market Value of Equity = Book Value of Equity + Present value of all future EVA

Diagrammatically it can be shown as:

EVA1 + EVA2 + (1+r) (1+r)2 -EVA1 + - EVA2 + (1+r) (1+r)2

Advantages of Economic Value Added o Measuring Profits the way shareholders count them: Peter Drucker has put the matter in a Harvard Business Review article as, "Until a business returns a profit that is greater than its cost of capital, it operates at a loss. Never mind that it pays taxes as if it had a genuine profit. The enterprise still returns less to the economy than it devours in resourcesUntil then it does not create wealth; it destroys it." EVA corrects this error by explicitly recognizing that when managers employ capital they must pay for it, just as if it were a wage. Management System: EVA can give companies a better focus on how they are performing, its true value comes in using it as the foundation for a comprehensive financial management system that encompasses all the policies, procedures, methods and measures that guide operations and strategy. The EVA system covers the full range of managerial decisions, including strategic planning, allocating capital, pricing acquisitions or divestitures, setting annual goals-even day-to-day operating decisions. In all cases, the goal of increasing EVA is paramount and thus removes a lot of confusion

o

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o

Financial measure line managers understand: EVA has the advantage of being conceptually simple and easy to explain to non-financial managers, since it starts with familiar operating profits and simply deducts a charge for the capital invested in the company as a whole, in a business unit, or even in a single plant, office or assembly line Ending the confusion of multiple goals: Most companies use a numbing array of measures to express financial goals and objectives. Strategic plans often are based on growth in revenues or market share. Companies may evaluate individual products or lines of business on the basis of gross margins or cash flow. Business units may be evaluated in terms of return on assets or against a budgeted profit level. Finance departments usually analyze capital investments in terms of net present value, but weigh prospective acquisitions against the likely contribution to earnings growth. EVA is the only financial management system that provides a common language for employees across all operating and staff functions and allows all management decisions to be modeled, monitored, communicated and compensated in a single and consistent way always in terms of the value added to shareholder investment.

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Pitfalls of EVA EVA is a value based measure, and it gives in valuations exactly same the answer as discounted cash flow, the periodic EVA values still have some accounting distortions because EVA is after all an accounting-based concept, suffering from the same problems of accounting rate of returns (ROI etc.). In other words the historical asset values that distort ROI do distort EVA values also. EVA is the excess of ROI over WACC multiplied by the capital employed and thus as the ROI suffers from serious limitations of wrong periodizing and distortions caused by inflation the same gets incorporated in EVA also.o

Wrong Periodizing: In case on a single project the normal depreciation schedules cause the ROI and consequently EVA to be small at the beginning of a project and big at the end of the project. ROI is low at the beginning of the project as the capital base is high while at the latter stages the ROI shoots up because of the low capital base. Distortions caused by Inflation and Capital Structure: EVA is affected by the accounting policies. Thus in long run a higher EVA will be reported if for example R&D costs are charged to the income statements and are not capitalized. Similarly inflation brings about distortion in the value of assets and affects EVA. Paradox of EVA: We know that Market Value of Equity = Book Value of Equity + PV of all future EVA

o

o

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Thus the EVA valuation has two components book value and future EVA and by increasing the book value of equity we actually reduce the future EVA because of the capital costs and vice versa. Implications EVA is based on the common accounting based items like interest bearing debt, equity capital and net operating profit and it is usually always good when EVA increases and always bad when EVA decreases. Industries like telecom, forestry products, pharmaceuticals, semiconductors etc are the ones with very cyclical investments (not smooth over the years) and/or industries with very long investment horizon suffer most from the pitfalls of EVA. But even in such industries the EVA financial management system can be successfully implemented with changes in the accounting procedure like changes in depreciation schedule. In other industries with a lot of current (instead of fixed) assets and with short investment period EVA can be easily used to the benefit of the shareholders. Introduced by Stern Steward and Company, EVA purports to assess shareholder value by calculating the amount by which profits exceed the cost of capital. Some critics say that EVA has a low correlation to shareholder value. Companies that use EVA often try to increase short-term shareholder value by minimizing their cost of capital. Managers become reluctant to invest in future growth because capital that hasn't yet generated a profit reduces EVA. Such short-sighted approach can limit a company's growth. EVA does not fit Internet start-ups because earning a positive EVA isn't all that important -- the key for start-ups is developing the product pipeline. EVA is a good measure of performance but by itself the metric is not a good indicator of how much shareholder value a business is generating. Investors need a measure that does not penalize investment.

Economic value addition in businessThe concept:

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In simple terms, economic value added is the profit that remains after deducting the cost of the capital invested to generate the profit. It is obvious that one can get richer if he invest money at a higher return than the cost of that money to him. The cost of the capital in the EVA equation includes equity capital as wellas debt capital. Calculating cost of debt is easy- it is basically the interest paid on the firms new debt. The equity calculation is more complex as it varies with the risk the shareholders takes. A company creates value only if the return of the capital is greater than the opportunity cost of it or the rate the investors could earn by investing in other security with same risk. If the result is positive then the firm created value over the period in question. The EVA is negative it is a value destroyer. EVA is a essentially a repackaging of sound financial management and corporate financial principles that have been around for long time. Computation of EVA 1. Economic capital = Shareholders equity + + + good will written off Capitalised cumulative unusual loss Deferred tax +minority interest +total debt

2. Net operating profit after tax (NOPAT) = Operating profit + _ _ Interest expense Unusual gain Taxes

3. Weighted average cost of capital(WACC)

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Cost of equity Cost of debt WACC = (average out) 4. EVA = NOPAT- (capitalWACC)

Lets now look at the overall calculation, which can be broken down into three sets of calculations. Each of these is the mathematical implication of one of the three main ideas supporting the entire economic profit system: IDEA Cash flows are the best indicators of performance. The accounting distortions must therefore be fixed. Some expenses are really investments and should be capitalised on the balance sheet. True investments must therefore be recognised. Equity capital is expensive(or at the very least nor free). This expense must therefore be accounted for. IMPLICATION Translate accrual based operating profit(EBIT) into cash based net operating profit after taxes(NOPAT). Reclassify some current expenses as balance-sheet(equity or debt) items. Deduct a capital charge for invested capital

Profits the way shareholders count them By taking all capital costs into account including the cost of equity, EVA shows the money value of wealth a business has created or destroyed in each reporting period. In other words, EVA is profit the shareholders define it. If the shareholders expect, say , a 10% return on their31

investment, they make money only to the extend that their share of after-tax operating profits exceeds ten percent of equity capital. Everything before that is just building up to the minimum acceptable compensation for investing in a risky enterprise. The pioneering studies of Stewart According to Stewart (1991:215), financial analysts Stern Stewart & Co. started tracking the best 1000 industrial and services companies in the United States of America (USA) in 1989, after he had become disillusioned with the company rankings of the magazine Business Week at the time. These rankings were based on market capitalization and not on performance. Stern Stewart & Co. began to rank companies based on MVA. As they had expected, the new rankings were dramatically different from the Business Week rankings. Taking the Stern Stewart 1000 companies as a point of departure and eliminating some companies for various reasons, such as incomplete information, Stern Stewart & Co. did some research on the EVA and MVA of 613 companies in the USA. The companies were ranked in terms of the average EVA for 1987 and 1988. The study was based on the average EVA and MVA for each of 25 groups of companies (making up the 613), as well as on changes in EVA and MVA. The groups were made up according to the companies rankings in terms of average EVA. The research found that for companies with a positive EVA, there was a very high level of correlation (as indicated by r2) between the level of EVA and the level of MVA, both for the average values used and the changes in values. The averages (per group of 25 companies) of the 1987 and 1988 EVA values showed an r2 of 97%, relative to the 1988 MVA values. The relationship for the changes in values was even better than that for the average values. For the groups of companies with a negative EVA, the correlation between the EVA and MVA levels was not as good. Stewarts (1991) explanation for this was that the market value of shares always reflects at least the value of net assets, even if the company has low or negative returns. The potential for liquidation, recovery, recapitalisation or a takeover sets a floor on the market value (in other words, the market value does not drop far below the net asset value).

Finegans extensions of the EVA and MVA applications

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Finegan (1991:36) extended the initial analysis discussed above to include other measures. He focused on the middle 450 companies (actually 467 companies out of the original 613) where the MVAs were tightly clustered and compared the power of EVA to that of more conventional measures such as EPS, growth in capital, return on capital and even growth in cash flow. The results of the regression of MVA against EVA and other common performance measures showed that EVA outperformed the other measures quite considerably with an r2 of 61%, compared to the second best other measure, which was return on capital, with an r2 of 47%. The explanatory power of EVA was found to be six times better than that of growth in EPS. Finegan (1991:36) then repeated the analysis of changes in MVA and again found EVA to be superior to the other measures. The r2 of changes in EVA was 44%, compared to an r2 of 35% for changes in return on capital, which was the measure that came closest to EVA in terms of its explanatory power. In this analysis, the r2 of EVA was about three times better than that of changes in EPS growth. Sterns comparison of EVA with popular accounting measures Stern (1993:36) argues that the key operating measure of corporate performance is not popular accounting measures such as earnings, earnings growth, dividends, dividend growth, ROE, or even cash flow, but in fact EVA. The changes in the market value of a selected group of companies (specifically their MVAs) have been shown to have a relatively low correlation with the above accounting measures. His research showed that the r2 for the relationship between MVA and various independent variables ranged from 9% for turnover growth to 25% for ROE rates. By comparison, the r2 for EVA relative to MVA was 50%. All the results were based on averages and they are set out in Table 1. Table 1 MVA vs other financial performance measures Correlation with MVA EVA ROE Cash flow growth EPS growth Asset growth R2 50% 25% 22% 18% 18%33

Dividend growth 16% Turnover growth 9% Source: Adapted from Stern (1993:36) Lehn and Makhijas work on EVA, MVA, share price performance and CEO turnover Lehn and Makhija (1996:36) conducted a study to find out how well EVA and MVA relate to share price performance and to see whether chief executive officer (CEO) turnover (the number of new CEOs during a given period) is related to EVA and MVA. They selected 241 large US companies and gathered information about them for the four years 1987, 1988, 1992 and 1993. About two thirds of the companies operated in the manufacturing industry. Six performance measures were computed per company for each of the four years, namely three accounting rates of return (ROA, ROE and return on sales [ROS]), share returns (dividends and changes in share price), EVA and MVA. All six measures correlated positively with share returns. EVA correlated slightly better with the share returns than the other measures did.Lehn and Makhijas findings regarding EVA, MVA and CEO turnover revealed that the CEOs of companies with high EVAs and MVAs had much lower rates of dismissal than CEOs responsible for low EVAs and MVAs. As expected, a strong inverse relationship was found between share prices and CEO turnover. The CEO turnover rate for companies with share returns above the median was 9.6%, compared to a 19% turnover for companies with share returns below the median. In their study of the relationship between EVA, MVA and corporate focus, Lehn and Makhija (1996:36) distinguished between companies that focus on their core business and ones that diversify and become conglomerates in the hope of exploiting economies of scale. Their research showed that companies with an above median focus earn an average share return of 31.2%. Firms with a below median focus earn 25%. These findings prove that a greater focus on business activities leads to higher levels of EVA and MVA. Lehn and Makhija (1996:36) have concluded that EVA and MVA are effective performance measures that contain information about the quality of strategic decisions and that serve as signals of strategic change.

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OByrnes findings on EVAs link to market value and investor expectations OByrne (1996:119) used nine years of data (for the period from 1985 to 1993) for companies in the 1993 Stern Stewart Performance 1000 to test the explanatory power of capitalized EVA (which is EVA divided by the cost of capital), net operating profit after tax (NOPAT), and free cash flows (FCFs) relative to market value divided by IC. His initial findings showed that FCF explained 0% of the change in the market value divided by the capital ratio, while the r2 was 33% for NOPAT and 31% for EVA. It looked as if NOPAT and EVA had almost the same explanatory power. Two adjustments were made to the original model of Stern and Stewart. The first adjustment allowed for the fact that the EVA multiples were bigger for companies with a positive EVA than the EVA multiples for companies with a negative EVA. The second adjustment allowed for different capital multiples for different capital sizes, in other words, a bigger multiple was used for companies with more invested capital. This adjusted model showed that EVA explained 31% of the variance in market values, compared to the 17% explained by NOPAT. After making a further adjustment, by analysing the changes in the variables, changes in EVA explained 55% of the five-year changes in market value, compared to 33% explained by NOPAT. The corresponding figures for ten-year changes in market value were 74% explained by changes in EVA, compared to 63% explained by NOPAT. OByrne (1996:119) concluded that EVA, unlike NOPAT or other earnings measures, is systematically linked to the market value and that EVA is a powerful tool for understanding the investor expectations that are built into a companys current share price.

Uyemura et al. EVA and wealth creation Uyemura et al. (1996:98) used a sample of the 100 largest US banks for the ten-year period from 1986 to 1995 to calculate MVA and to test the correlation with EVA, as well as four other

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accounting measures, namely net income (amount), EPS, ROE and ROA. The results of their regression analysis are set out in Table 2.

Table 2 Correlation of different performance measures with shareholder wealth Performance measure EVA ROA ROE Net income (amount) EPS R2 40% 13% 10% 8% 6%

Source: Uyemura et al. (1996:98)

The analysis above clearly shows that EVA is the measure that correlates the best by far with shareholder wealth creation. In an alternative approach where changes in the performance measures were regressed against standardised MVA, the results were not very different. Standardised EVA (EVA divided by capital) again had an r2 of 40%, while for ROA it was 25%, for ROE it was 21%, for net income it was 3% and for EPS it was 6%. Grants analysis of relative EVA and relative capital invested Grant (1996:44, 1997:39) studied the relationship between MVA divided by capital and EVA divided by capital for 983 companies selected from the Stern Stewart Performance 1000 for 1993 and 1994. The results for 1993 showed an overall r2 of 32% for all the companies. For the 50 largest US wealth creators, the r2 was 83%. For the 50 biggest US wealth destroyers, it was only 3%. When the same tests were repeated for 1994, they showed that the r2 was 74% for the 50 largest wealth creators and 8% for the 50 largest wealth destroyers. This is in line with the findings of other researchers. These findings revealed a high level of correlation between MVA

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and EVA for companies with a positive EVA, but low levels of correlation for companies with a negative EVA. Grant (1996) found that the real corporate profits should be measured relative to the amount of capital needed to generate that level of profitability. This insight led him to use standardized values for EVA and market value, instead of absolute values. He concluded that his empirical results indicate that EVA has a significant impact on a companys MVA. The value of a company responds to variations in both the near-term EVA outlook and movements in the long-term EVA growth rate.

Milunovich and Tsueis study on the use of EVA and MVA in the US computer industry Milunovich and Tsuei (1996:111) investigated the correlation between frequently used financial measures (including EVA) and the MVA of companies in the US computer technology industry (so-called server-vendors) for the period from 1990 to 1995. The results of their study are set out in Table 3. Table 3 Correlation of different performance measures with MVA in the US computer technology industry Performance measure EVA EPS growth ROE Free growth FCF cash r2 42% 34% 29% 25% 18%

Source: Milunovich and Tsuei (1996:111)

Clearly EVA demonstrated the best correlation and it would be fair to infer that a company that can consistently improve its EVA should be able to boost its MVA and therefore its shareholder37

value. Milunovich and Tsuei (1996:111) argue that the relatively weak correlation between MVA and FCF is due to the fact that FCF can be a misleading indicator. They point out that a fast-growing technology start-up company with positive EVA investment opportunities and a loss-making company on the verge of bankruptcy can have similar negative cash flows. They concluded that growth in earnings is not enough to create value, unless returns are above the cost of capital. They are of the opinion that EVA works best as a supplement to other measures when one is evaluating shares and that EVA sometimes works when other measures fail. Measuring shareholder value Value-based performance measurement: Performance measurement is the method of assessing a companys progress towards achieving its preset goals. Through key performance measures, an organisations strategy is linked to its operations. The objective of performance measurement and management is to increase the shareholder value, profitability, growth, competitiveness, quality, customer satisfaction, etc. of an organisation resulting in improved performance (Moncla & Arents-Gregory 2003). An important concept in performance measurement is benchmarking. Benchmarking is the systematic process of searching for the best business practices, innovative ideas and effective operating procedures to fuel progress and improvement (Bogan&English 1994,p.1). Benchmarking enables companies to compare their key performance measures internally or externally. An organisation can study practices and measure performance from within itself, or against its industry peers. Benchmarking helps organisations refine their strategy through the re-examination of products, prices, practices, strategies, structures and services against competitors and other industry leaders (Bogan & English 1994,p.9).

A particular category of performance measures are financial performance measures. Financial measures indicate to top-management whether their strategy execution is leading to better bottom-line results (Niven 2003, p.19). The financial metrics are based on information obtained from balance sheets, income statements and cashflow statements (Bogan & English 1994, p. 57). Some examples of these metrics are revenue, gross profit, operating income, net income, earnings per share, long-term debt, cash flow, debt/equity ration, etc. By adopting a

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performance measurement system based on financial measures, companies can identify the key performance metrics that would result in improved financial outcomes. As customers place an increasing demand on companies to provide value-added services, it is becoming vital for companies to be able to measure the value of these services in order to justify a premium price for the services and ensure continued profitability (Lambert & Burduroglu 2000). Many organisations have adopted a new breed of performance measure that are based on shareholder value, known as value-based management. Shareholder value is the financial value created for shareholders by the companies in which they invest (Christopher&Ryals 1999, p. 2).Ashareholder is any holder of one or more shares in a company. The evidence of being a shareholder is in the form of a stock certificate. The shareholder value theory states that a company creates this value when it meets or exceeds a cost of capital that suitably reflects its investment risk (Lambert & Burduroglu 2000, p. 10). Companies are choosing to employ a system of measuring shareholder value for many reasons (Copeland et al 1994, p. 22). First, value is the best metric of performance as it is the only measure that is comprehensive and hence is useful for decision-making. By increasing shareholder value, companies can maximize the value for other stakeholders (customers, labour and government (through taxes paid) and suppliers of capital). Second, shareholders are the only stakeholders of a company who simultaneously maximize everyones claim in seeking to maximize their own. Finally, companies that are unable to create shareholder value will find that capital flows away from them and towards their competitors who are creating shareholder value. The most common methods for measuring shareholder value are (Lambert & Burduroglu 2000, p. 2): Customer satisfaction and customer value-added (CVA) Total cost analysis Profitability analysis Strategic profit model (SPM) Economic value-added (EVA)

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Economic value-added (EVA) Stern Stewart & Co (www.sternstewart.com/) created the EVA to aid managers in their decision-making by incorporating two basic concepts of finance. The first is that the objective of any business is to maximize the value created for the companys shareholders. Second, the value of a company is dependent on the extent to which shareholders expect earnings to be greater than or less than the cost of capital. A continuous increase in EVA will result in an increase in the market value of the company. EVA has been adopted by many companies including Coca Cola Inc, DuPont, AT&T, Quaker Oats and General Motors. In a Stern Stewart Research Special Report (Stewart et al 2002), companies that implemented the EVA in the 1990s outperformed their peers by an average of 8_3% per annum over the five years following its adoption, and created total excess shareholder wealth of $116 billion. The report also showed that even in periods of economic slowdown, EVA clients earned a total return of 36_5% and beat the S&P 500 by a total of 69_8%. The reason so many companies have adopted the EVA and have realized financial benefits are due to the advantages of its use. EVA highlights the areas of the company that create value. This enables managers to take decisions on increasing the efficiency of their capital and operations by focusing work on areas with higher productivity. EVA-based financial management gives managers superior information, motivation, empowerment and accountability to ensure that their decisions create the greatest amount of shareholder value. EVA aligns the decisions managers take with the creation of shareholder wealth. EVA is the net operating profit after tax (NOPAT) minus the capital charge of a company. The NOPAT of a company is defined as the operating profit after taxes have been deducted. It is the return on the companys total capital invested. The capital charge is an appropriate charge for the opportunity cost of all capital invested in a company. EVA shows the dollar amount of wealth a company has created or destroyed. The information required to calculate a companys EVA is obtained from a companys income statement and balance sheet. Table 1shows how to calculate a companys EVA. Figure 2 shows how the above steps lead to

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the calculation of the EVA of a company. The significant components of a companys capital (C) are the working capital, the fixed assets and the intangible assets (e.g. goodwill and patents). The companys working capital is difference of the total current assets and the current liabilities. The current assets include the companys accounts receivables, inventory, prepaid expenses, cash and other current assets. The current liabilities is the sum of accounts payable, notes payable and accrued liabilities, less short-term debt. A company can increase its EVA in the following ways. -Increasing NOPAT by increasing operating income -Reducing the capital charge by reducing the companys capital and cost of capital

EVA is also shareholder-centric and hence of little relevance to the rest of the stake holders. EVA is identical to residual income, which was largely abandoned by US companies years ago (Keys, Azamhuzjaev, and Mackey, 2001).

Value-based management (VBM) has been referred to as the fastest and hottest ticket to shareholder wealth. Incorporating such techniques as economic value added (EVA), return on operating invested capital (ROIC), and market value added (MVA), VBM is a complete financial management and incentive compensation system that guides decision-making at every level. Adopting companies use VBM as a guide in financial planning, monitoring, and controlling operations. This article illustrates the computation of EVA, ROIC, and MVA for Toll Brothers, Inc., a company in the home-building industry, which is generally characterized as having a high volatility of investment needs. The company is of average size for the industry, with a market capitalization of $1,742 million. Typical of the industry, the company exhibits relatively sporadic growth, but has maintained an average annual revenue growth of 18% over the last five years.

A method of performance evaluation that adjusts accounting performance for investors' required return on investment. Suppose a division produces a 12% return on capital invested. Given the risk of the division's business line, if investors would usually require 14% on capital invested for this level of risk, the division destroyed shareholder value by the EVA metric. This SternStewart has a trade mark on this term.

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Economic Value Added: Theory, Evidence, A Missing Link. by Ray, Russ Review of Business Spring, 2001 Evidence is mixed regarding the efficacy of Economic Value Added (EVA), the relatively new financial-management tool. This analysis offers a new definition of value, and suggests that the missing link in the EVA process is productivity, generally found to be the engine of all economic growth. Introduction In recent years, Economic Value Added has been touted by the popular press as the financial savior of the corporate world. Indeed, Fortune magazine -- in a 1993 cover story -- described EVA as "today's hottest financial idea and getting hotter." Corporate giants such as Coca-Cola, AT&T, Briggs-Stratton, DuPont, Eli Lilly, Quaker Oats, and others have adopted this new financial tool and, in many instances, reported significantly improved financials. A good example of EVA involving Coca-Cola and General Motors is presented in [4]. Coca-Cola, one of the earliest users of EVA, saw its stock price increase from $3 (on a split-adjusted basis) in 1981, when Coke first adopted EVA, to over $60. Moreover, its Market Value Added (MVA), calculated as the market value of all stock outstanding less its book value, increased by a factor of ten. Coke's EVA experience seemingly contrasts sharply with the experience of some other firms not employing EVA, notably General Motors. By 1995, before the U.S. bull market significantly inflated stock prices, the market value of GM's stock was $69 billion. However, up to that year, investors had cumulatively supplied GM with $87 billion of equity, so GM was actually destroying capital as it manufactured cars.

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In terms of stock price, GM's shareholders received only $.79 of wealth for every $1.00 they had cumulatively invested in GM, as of 1995. In sharp contrast, Coca-Cola's investors received $8.63 in wealth for every dollar invested by 1995. If the bull market of the 1990's is factored in, GM's investors have finally broken even, while Coca-Cola's investors have realized even greater returns. On the surface, EVA is seemingly a powerful new financial management tool which is being used successfully and increasingly by some of our "best" corporations. However, when the empirical surface is scratched, EVA doesn't seem to be quite the elixir purported by its proponents. Indeed, EVA may be nothing more than a clever (and lucrative) re-packaging of some very old business principles. This article reviews the theory and evidence regarding EVA, and places EVA within the larger context of valuation metrics. The analysis attempts to resolve the conflicting studies regarding EVA by offering a new hypothesis, viz., that the missing link between EVA and improved financials is actually productivity, incrementally aided by a well-documented measurement effect. The following section defines value in such a way that the importance of productivity can be later identified. The section thereafter places EVA within the larger context of valuation metrics. Subsequent sections review the literature and suggest that the ongoing empirical dispute about EVA can be resolved by recognizing productivity (aided by a "measurement effect") as the missing link between EVA and better financials. What is "Value"? It may be helpful to begin this discussion by defining its core term. Value is simply the quality/price which is perceived/paid by the customer. The quality component of value includes the inherent quality of the particular product or service, as well as all of its auxiliary features (follow-up service, complaint resolution, etc.). From the viewpoint of the customer, the price of the product or service must at least be commensurate with - or, ideally, commensurately lower than - the perceived value of the product or service received, or else the customer will feel that he or she has not received real value from the

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exchange. In the long run, if a firm's customers perceive that they're not receiving value, then the firm will almost certainly become just another corporate fatality (assuming free markets, of course). Valuation Metrics In any discussion of value added, the key question becomes, How is value measured? Valuation metrics - the empirical measuring of value added - include accounting value, economic value, net present value, and, now, Economic Value Added. Accounting value essentially measures the value added by a firm as the change in the firm's earnings. Although a relatively precise measure, accounting value suffers from some well-known deficiencies. First, accounting earnings net out non-cash expenses, and are thus not a true measure of the actual cash earnings generated by a firm. Secondly, accounting metrics ignore the returns required by shareholders. (Obviously, a million dollar accounting profit would be grossly inadequate if it required a trillion dollars of shareholders' money to accomplish the result.) Finally, accounting metrics tend to be single-period measures, which can always be maximized by ignoring the long run health of the firm (e.g., by delaying or avoiding routine maintenance). The second measure utilized in valuation metrics is economic value, which is residual income left over after all suppliers of capital have been adequately compensated for the risk they've incurred. Although a superior metric than accounting value, economic value is difficult to measure, primarily because hard to ascertain. Besides, it, too, is a single period metric. Net present value (NPV) overcomes the drawbacks of both accounting and economic metrics. In addition to measuring incremental cash flows (the real income occurring to a firm from a particular project) over a multi-period time frame, it also considers the returns required by all suppliers of capital, as imbedded in the Weighted Average Cost of Capital (WACC), and as adjusted on an aftertax basis. Not surprisingly, NPV has been extensively (and successfully) utilized for decades as the preeminent decision rule in project adoption. EVA The newest evaluation metric is Economic Value Added, commonly referred to as "EVA," which is a registered trademark of Stern Stewart & Company, the New York consulting firm which

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developed this tool. In its essence, EVA is Net Operating Profit After taxes (NOPAT) less the dollar cost of the capital required to create that profit. The idea is not new: the return on any given increment of capital must be greater than the cost of that capital. Indeed, the capital budgeting tool of internal rate of return has embodied this principle for many decades. However, the EVA measurement process departs (sometimes considerably) from conventional accounting standards; and, in fact, Stern Stewart & Company utilize 164 variations (at last count) of their metric, depending upon the peculiarities of the particular firm they're advising. Some of these applications are at significant variance with Generally Accepted Accounting Principles (GAAP), such as the capitalization of R&D and advertising. In its simplest form: [EVA.sub.t] =[r.sub.t] - [K.sub.t])[C.sub.t-1] (1) where [r.sub.t] is the firm's return on capital at time t, i.e., [r.sub.t] = [NOPAT.sub.t] / [C.sub.t-1] (2) [k.sub.t] is the firm's WACC at time t, and [C.sub.t-1] is the firm's (or division's, or department's...) capital at the beginning of the period. Since its inception, EVA has received a lot of very favorable press. Indeed, such prestigious publications as Fortune, Investor's Business Daily, CFO, Financial Executive, Management Review, Chief Executive, and the Wall Street Journal have touted its virtues. Needless to say, the principals of Stern Stewart have been well remunerated in the process. Critics of EVA argue that it is nothing more than NPV re-packaged at departmental, divisional, and firm-wide levels. They argue that Stern Stewart & Company's only real contribution to the capital budgeting and incentive compensation process is the development of (arguably, arbitrary) measures with which to implement NPV on scales larger than a project basis. Such measures include capitalizing advertising, R&D and certain other expenses in order to ascertain the exact capital base being utilized (the denominator in equation (2)). After identifying the capital base, the firm is then able to use NOPAT to find its return on capital and, ultimately, its EVA.

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The evidence in favor of EVA is mainly (but not entirely) anecdotal. One study [7] reports 250 firms currently, and satisfactorily, using EVA For such firms, some researchers [1, 2] report very positive ad hoc experiences with EVA On an empirical level, significant correlation between EVA and MVA has been found [13,11]. A positive relationship between EVA and shareholder returns has also been found [9]. The evidence against EVA essentially finds poor statistical relationships between EVA and various financial measures. Some researchers [3] find little relationship between EVA and MVA (and, hence, stock price), while others [101 find statistically poor relationships between EVA and shareholder returns. Other studies [6] report that "the market seems more focused on 'profit' than EVA." In summary, the evidence is mixed, as so often happens when new techniques, new theories, and new processes are introduced. (For a more comprehensive review of this conflicting evidence, see [5].) So far, however, neither body of evidence seems to significantly outweigh the other. This study seeks to resolve this controversy by suggesting that the missing link in the EVA process is productivity, a factor which has so far been ignored by both the proponents and the critics of EVA. This article argues that EVA is simply a measuring tool (albeit, if used correctly, a powerful one), which points out where value is being created by the firm, and where it's not. In other words, EVA does not create value -- it simply measures it. What the firm does with this measure - it might even choose to ignore it - is a totally separate matter; in a rational market, maximizing EVA should maximize the firm's share price and, hence, shareholder wealth. The real reason why a firm's financials might improve after EVA adoption is twofold: 1) the measurement effect; and, 2) productivity increases - the real missing link between EVA and better financials. The Fishbowl Factor So what is the "measurement effect"? As common sense would suggest, and as numerous studies have confirmed, the quantity and quality of employees' output increase when these same employees know that their output is being measured. After all, almost all of us perform better when we know we're in the limelight (or, more precisely, a limelighted fish bowl), and especially when we know that our livelihoods are at stake. This is simply human nature.

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As applied to EVA, this self-fulfilling effect means that every person in the firm knows that they are being held accountable for every dollar allotted to them. Moreover, each person also knows that they are expected to turn that dollar into something greater than a dollar - say, $1.15. If this transformation doesn't take place, the employee will soon realize another age-old principle: no ticket, no laundry. As might be expected, EVA thus spurs people to get their corporate act together, and soon. Not surprisingly, this "survival incentive" causes greater value to be created for the customer. EVA and Productivity The second (and predominant) factor at play in the EVA process is the driving force behind all economic growth - productivity. In the long run, productivity is the driving force behind success at every level: national, industry, firm, division, department, and even at the individual level (holding, of course, political factors constant). At the national level, countries with powerful productivities continually enjoy rising standards of living and greater productive capacities (witness, in particular, the U.S. with its technology-driven productivity increases of recent years). At the corporate level, productive firms generally realize rising share prices and, in fact, improved performances in all of their financials (profits, cash flow, stock prices, etc.). Doubters of this productivity premise are referred to a watershed 1993 study by the U.S. Department of Labor, "High Performance Work Practices and Firm Performance." The study is essentially a massive review of the literature on productivity, which is found to be the ultimate driving force behind real economic growth and better financials. Probably the best way to see the relationship between EVA and productivity is to distill the EVA measuring tool down to its essence by reformulating equation (1) to the general expression: EVA = (r-k) capital (3) where r is, again, the firm's return on its capital (the sum total of all assets being employed), and k is the (weighted-average) cost of that capital. As many frustrated CFO's can attest, the firm's cost of capital is, more or less, determined by market forces (and, in particular, by how the market perceives the firm's riskiness). Conceivably, the firm

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could lower its cost of capital by mixing in more debt, but this creates more risk for shareholders, and it also removes the firm from its optimal capital structure (where, presumably, it was operating in the first place). Thus, the firm's capital cost is largely determined by outside forces, and is essentially a given over which the firm has little control. Algebra aficionados might point out, especially after seeing equation (2) presented previously, that reducing capital is another way to increase EVA, but this presumes that the firm is inefficient, i.e., using more capital than it needs to achieve any given outcome. If this is the case, then the potential for improvement exists in many areas by simply requiring the same output with less capital. (And some firms, such as CSX, have used EVA to effect such requirements.) This analysis focuses on firms which are already reasonably efficient. As an anonymous referee has pointed out, a firm could increase its return on capital (and, hence, its EVA) by understating its assets. Such manipulation should, except for an occasional instance, be minimal if scrupulous auditors require the firm to consistently employ Generally Accepted Accounting Principles. Moreover, as this same referee also pointed out, depreciation can affect a firm's EVA-return on capital. In general, accelerated depreciation (chosen almost universally by firms in order to minimize taxes), would tend to understate (relative to straight-line depreciation) the EVA returns on capital, since the impact would have a greater percentage-change effect upon the numerator in equation (2) than upon the denominator. However, this understatement will be uniform and consistent, so that it is not significant for EVA decision-making purposes. If the cost of capital is a given, then obviously the only way for a reasonably efficient firm to increase its EVA is to increase its return on capital. So now the million-dollar question becomes, "How does a firm increase its return on capital"? The award-winning answer: primarily, by increasing its productivity.

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What is Productivity? Productivity is a funny animal. First, it must be matched to consumer demand. A firm could be the most productive ever at manufacturing buggy whips, but its long-run health would be doubtful, to say the least. On the other hand, a firm could be embarrassingly non-productive, but if