Regulated businesses make for awkward cases: you cannot simply raise prices or cut your way out. This management consulting case study uses economic value added (EVA) to show where a water utility can still find room to move.
Case Scenario
The client is a German-owned water utility headquartered in the Northeast United States. An internal financial assessment method known as EVA (economic value added) is used by the client to assess its performance. This method stresses how earnings and a capital charge together determine the company's return.
The EVA function is operating income (after taxes) less the fair return on invested capital (WACC × capital asset base).
The client's company is currently experiencing negative EVA. How would you go about making EVA equal to zero and then making it positive?
Additional Information
Due to regulation, pricing depends on consumption and cannot be changed considerably. The capital base, which is mostly made up of water filtration and distribution apparatus and equipment, has not undergone any substantial modifications. Overall, costs have stayed quite steady.
Key Questions
The firm has to expand in order to broaden its revenue base. The candidate should consider options for future growth and how to recover from setbacks.
- Why not provide bottled water instead?
Although providing bottled water is a nice concept, putting it into practice would probably be challenging without adding more expense for delivery, packaging, branding and so on. - What about extending the business to new areas?
Regulatory issues and other businesses might be obstacles to growing into other locations. History shows that the local community and businesses are opposed to this company's expansion.
Solutions
Since the WACC term makes up the other part of the equation, the first term carries the equation's weight, which indicates that operating profits have the greater impact on EVA. Once you realise that a significant percentage of EVA is driven by operating earnings, you need to investigate the factors that influence them. However, you shouldn't fully discount the capital asset base, since you want to be thorough in your study. The candidate should research what assets make up the capital asset base as a starting point, before looking at the consequences for top-line revenue and then the cost components.
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