Our issue:Use opportunity Cost logic to explain the imputed charge Cadbury needs to reflect on its books to account for the low-interest loans extended to its Managers.

In 1990, Cadbury India offered its employees free housing in company-owned flats (apartments) to offset the high cost of living in Bombay (now Mumbai). In 1991, when Cadbury added low-interest housing loans to its benefits package, employees took advantage of this incentive and purchased their own homes, leaving the company flats empty. The empty flats remained on the company's balance sheet for the next six years.

In 1997, Cadbury adopted Economic Value Added (EVA), a financial performance metric trademarked by Stern Stewart & Co. The main difference between ordinary accounting profit and EVA is that EVA includes a capital charge of 15%, representing the return that Cadbury could have made if it had invested the capital tied up in the apartments.

By charging each division within a firm for the amount of capital it uses, EVA gives division managers an incentive to incur capital expenditures only if they earn more than they cost, for example, by giving division managers an incentive to reduce capital expenditures if they earn less than 15%.

After adopting EVA, Cadbury India's annual EVA dropped by 600,000 (15% cost of capital times the 4,000,000 capital tied up in the apartments). In response, senior managers decided to sell the unused apartments as they were earning less than the company's cost of capital.

If the Cadbury managers had a good sense of their factories' variable, fixed, and total costs, why were they holding on to the company-owned flats?

To answer this question, we recognize another important distinction: the difference between accounting costs and what economists call "economic costs." The difference is especially important to big decisions about whether to buy or sell assets. For these decisions, you have to figure out what else you could do with the money if you decide to sell an asset. We measure the cost of using capital on any project by the returns we could get from investing it elsewhere, which accounting costs do not do.

These types of expenses are theaccounting costsof the business.

Economists, however, are interested in all therelevant costsof decisions, including theimplicit coststhat do not show up in the accounting statements. For an example of an implicit cost, look at the income statement again. Notice that it lists payments of capital providers of the company (debt holders).interestis the cost that creditors charge for the use of their capital. But creditors are not the only providers of capital. Stockholders provide equity, just as bondholders provide debt. Yet the income statement reflects no charge for equity even though this is an important consideration for investment decisions.

Suppose that Cadbury receives 4 billion in equity financing. If these equity holders expect an annual return of 12% on their money (480 million), we would subtract this amount from the 431 million in net earnings to get a better idea of theeconomic profitof the business, 49 million. Negative economic profit means that the firm is earning less than shareholders expect.

Had Cadbury shareholders expected only a 10.77% rate of return, the economic return would have been close to zero, and investors would have been satisfied. However, given that they expected a 12% return, they "lost" money in this investment, relative to what they could have earned elsewhere.

A failure to consider thesehiddenorimplicitcosts is why the Cadbury India managers continued to hold on to flats. By adopting EVA, the firm made visible thehidden cost of equity, and the mangers sold the abandoned flats.

In general, managers should consider all the benefits and costs of a decision. we introduce what economists call "opportunity costs."