ROIC+vs+WACC+is+harder+for+individuals,+Ann+Crotty,+B+Rep



=ROIC vs WACC is harder for individuals=

Business Report, April 12, 2006

 * By Ann Crotty**

Sitting through another day of competition tribunal hearings into allegations of anti-competitive behaviour against Mittal Steel South Africa, I find my mind wandering as I suffer another attack of what a colleague calls Mittal fatigue.

What if I'm not achieving an ROIC that is greater than my WACC? According to Mittal's expert witnesses, the steel giant is not achieving a return on invested capital (ROIC) that is greater than its weighted average cost of capital (WACC). This means Mittal really should just shut up shop because its business is not making enough money to cover the cost of financing.

In the case of Mittal, how the ROIC versus WACC calculation looks depends very much on how you do the depreciation and replacement sums.

Because the WACC model wasn't intended to be applied to individual endeavour, it does need some adjustment for the purposes of my wonderings. For instance, the notion of replacement costs could be applied to the huge costs of rearing children, while depreciation and maintenance might refer to medical, health and sundry other expenses. But the major consideration in applying the WACC model to individuals is whether or not the individual is earning enough to cover the cost of capital that's needed to live.

Unlike a business, the calculation for an individual should include all the income expected to be earned throughout the remainder of one's life, and the cost of capital includes all the costs expected to be incurred between now and death.

The sad reality is that unless you are one of those extremely lucky individuals who is currently a member of the elite club of corporate executives, there is a very good chance that your ROIC is significantly below your WACC.

But for individuals, unlike companies, this does not mean that you should call it a day. Far from it. It means you will probably have to work until the day you die in the vain hope of matching your WACC, or, put more colloquially, "in the hope of making ends meet".

That these thoughts were uppermost in my Mittal-fatigued mind was only partly attributable to the discussion at the hearing.

The fact that a disturbing number of my friends had recently been told by their financial advisers that they would have to work until they died has had a major and chilling impact on my psyche. The more so as it is at a time when there is so much news of top executives taking early retirement so they can smell the roses, achieve more balance in their lives or whatever.

And these friends of mine are not high-living, work-shy individuals. On the contrary, they work extremely hard under almost constant pressure and are comparatively modest consumers.

There are a limited number of ways of dealing with the grim financial situation that faces most of us. First of all, stop using financial advisers or use them very cautiously. This not only means that you will avoid hearing how bleak things are but it will save you a few bucks.

In this regard it is important to remember that financial advisers, money managers, bankers, consultants, brokers, whatever they are called, have a professional relationship with a large financial institution. This means they get paid not only by you but by a large institution to tell you stuff and perhaps even to sell you stuff. What you need to consider here is that a lot of the executives who are able to retire early because they can afford to are executives from financial institutions. And one of the major reasons that they can afford to is because the profits on selling financial advice and financial products are so high.

Then, of course, there's the option of cutting back on all your spending and saving everything you earn, which might make life seem very long indeed.

Finally, you could try to ingratiate yourself with your boss in the hope of being allowed to continue working until you die. The significant challenge here stems from the fact that your boss is likely to be changed on a constant basis as your company is put through frequent restructuring exercises, as well as mergers and acquisitions, in an effort by the senior executives to persuade the investment community that this is a dynamic company run by a hard-working, dynamic team of executives. In this regard the crucial issue for the executive team is not only that it is able to boost short-term profits by any means available in order to get another whacking great big bonus, but that the share price remains on an upward trajectory so that the share options will be hugely valuable.

All this means that the process of ingratiating yourself with your boss is fraught with danger and must be handled deftly. While ingratiating yourself, you must try to avoid attracting too much attention, as this could result in you becoming a target in the next round of downsizing or rightsizing exercises that are also regularly done to persuade the investment community of the dynamism of the top executives.

As a victim of one of these regular retrenchment exercises, you not only don't get the opportunity to work until you die but you are immediately faced with near penury. So consider the ingratiating option as the corporate equivalent of white water rafting in the Zambezi just below Victoria Falls: one wrong move and you're history.

Throughout all of this, it is important not to wonder if your ROIC is so low because your chief executive's is so high. Or vice versa. Because those sort of thoughts will only demotivate you as you contemplate a life filled with work.

Meanwhile, for me it's back to further contemplation of Mittal's ROIC and WACC.


 * From: http://www.busrep.co.za/index.php?fSectionId=553&fArticleId=3200940**

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