AC2720 Wk6 Analysis - Assignment 23-22 template Parts 1,2,3...

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Unformatted text preview: Assignment 23-22 template Parts 1,2,3: ROI, ROI, RI, EVA New Car Performance Parts Division ROI, RI, EVA and Assignment 23-25 template Part 1 Operating income after tax Net assets ROI RI Comment on results for parts 1: The choice of measure used to evaluate performance will determine which division gets However, the Cosmetics Division has much larger absolute and residual income. If Lucy Division will get the b The advantages of ROI are that it is easy to calculate and easy to understand. It combin can clearly see what can be changed to increase returns. But ROI has limitations. Manag with ROIs below their divisions’ current average ROI, even when Residual income has the advantage of goal congruence because any investment that increases the managers’ performance evaluations. The measure is not subject to the “c ROI to the average ROI being earned on existing investments. However, RI is not as easy capital and the cost of capital for Part 2: Adjusted operating income Net assets less current liabilities Revised ROI EVA Comment on results for parts 2: Because this is a manufacturing firm, there are a variety of nonfinancial performance response times that can be used to ensure that managers do not increase short-term op categories that are long-term driver Part 3: Your answer to part 3: ROI, RI, EVA and Performance Evaluation Clothing Cosmetics $800,000 $3,200,000 25% $448,000 $1,800,000 $7,500,000 24% $975,000 rmine which division gets the bonus. If Lucy uses ROI, then the Clothing Division will get the bonus. nd residual income. If Lucy evaluates performance based on residual income, then the Cosmetics Division will get the bonus. y to understand. It combines revenue, cost, and investment into a single number, so that managers OI has limitations. Managers who are evaluated based on ROI have incentives to reject investments t average ROI, even when the investments have positive net present values. ause any investment that earns more than the required capital charge increases RI and, thereby, ure is not subject to the “cutoff” problems that occur when managers compare a new investment’s However, RI is not as easy to measure because it requires the company to determine the amount of and the cost of capital for each business unit. Clothing Cosmetics $938,000 $2,680,000 35% $1,147,200 $7,170,000 16% $643,200 $358,500 onfinancial performance measures such as market share, customer satisfaction, defect rates, and not increase short-term operating income, residual income, or EVA at the expense of performance s that are long-term drivers of company value. Assignment 23-31 template ROI, RI, DuPont method, investment decisions, balanced scor 20 14 Part 1: Revenue Total Assets Print Internet 0.9 2.3 X Operating Income Revenues -0.2 0.03 Comment on results for parts 1: The Print Division has a relatively high ROI (18%) because of its high incom Internet Division has a low ROI (6.9%) despite a high investment turnover bec Part 2: 2014 ROI (before proposal) 18.00% Investment proposal ROI 13.95% 2015 ROI (with proposal) 17.62% Comment on results for parts 2: Given the existing bonus plan, any proposal that reduces the ROI is unattractive. So, Mays would not wis investment, which drops the Print division’s ROI from 18.00% to 17.62%. Part 3a: Residual income for 2014 (before proposal, in millions): Operating Income Print Internet Part 3b: 4500 690 Imputed Interes charge 2500 1000 Residual income for proposal (in millions): Operating Income 360 Imputed Interes charge 258 Comment on results for parts 3 a and b: Investing in the fast-speed printing press will increase the Print Division’s residual income by $102 million. evaluated using a residual income measure, Mays would be favorably inclined to adopt the computerized r system. Part 4 : Comment on results for parts 4: As discussed in requirement 3b, Mendenhall could consider using RI. The use of RI motivates managers to a makes a positive contribution to net income after the cost of the invested capital is taken into account. Makin have a positive effect on News Report Group’s customers. Mendenhall may also want to consider nonfinancial measures such as newspaper subscription levels, intern purchase patterns, and market share. These measures will require managers to invest in areas that have favo News Report Group’s customers. decisions, balanced scorecard Operating Income Revenues = Operating Income Total Assets -0.2 0.03 0.1 0.069 %) because of its high income margin relative to Internet. The gh investment turnover because of its very low income margin. tive. So, Mays would not wish to take on the new om 18.00% to 17.62%. Imputed Interest charge 2500 1000 Division Residual Income 2000 -310 l (in millions): Imputed Interest charge 258 Division Residual Income 102 dual income by $102 million. As a result, if Mays is to adopt the computerized reporting and printing f RI motivates managers to accept any project that is taken into account. Making such investments will p’s customers. er subscription levels, internet audience size, repeat vest in areas that have favorable long-run effects on rs. Assignment 23-32 template Part 1: oovveerrhheaaddallooccaatteedd oovveerrhhaadd llooccaatteedd Compensate managers on the basis of division RI: The benefit of this arrangement is that managers would be motivated to put in ex managers to excessive risk because each division’s RI depends not only on the ma low because of adverse factors (high interest, recession) that the manager canno arrangement. Thus, using mainly performance-based incentives will cost Menden performance-based rewards. The motivation for having some salary and some pe the manager. Finally, rewarding a manager only on the basis of divis Compensate managers on the basis of companywide RI: Rewarding managers on the basis of companywide RI will motivate managers to each division manager’s compensation will now depend not only on the perform Print Division, will depend on how well the manager of Internet performs, even th will impose extra Compensate managers using the other division’s RI as a benchmark: The benefit of benchmarking or relative performance evaluation is to cancel out t a manager’s performance. What is critical, however, for benchmarking and relati that affect the performance of the Print Division (cost of newsprint paper, for exa of the other division will not provide useful information for relative performance e the division managers of the Print and Internet Divisions to cooperate with one a Part 2: overhad located Using measures like RI and ROI—diagnostic levers of control—can cause mana problems by introducing and upholding strong boundary and belief systems of c Part 3: Another potential problem of an excessive focus on diagnostic measures is a uncertainties and the competitive landscape can help overcome this problem. M and obtain their field-based inputs. Such regular dia ccaatteedd ccaatteedd Division manager’s compensation, levers of control d be motivated to put in extra effort to increase RI because managers’ rewards would increase with increases in RI. But compensating m epends not only on the manager’s effort but also on random factors over which the manager has no control. A manager may put in a gr n) that the manager cannot control. To compensate managers for taking on uncontrollable risk, Mendenhall must pay them additional ncentives will cost Mendenhall more money, on average, than paying a flat salary. The key question is whether the benefits of motivati g some salary and some performance-based bonus in compensation arrangements is to balance the benefits of incentives against the e er only on the basis of division RI will induce managers to maximize the division’s RI even if taking such actions are not in the best intere I: will motivate managers to take actions that are in the best interests of the company rather than actions that maximize a division’s RI. A nd not only on the performance of that division manager but also on the performance of the other division managers. For example, the Internet performs, even though Mays herself may have little influence over the performance of these divisions. Therefore, compensati will impose extra risk on each division manager, and will raise the cost of compensating them, on average. a benchmark: valuation is to cancel out the effects of common noncontrollable factors that affect a performance measure. Taking out the effects of th or benchmarking and relative performance evaluation to be effective is that similar noncontrollable factors affect each division. It is not of newsprint paper, for example) also affect the performance of the Internet division. If the noncontrollable factors are not the same, th for relative performance evaluation. A second factor for Mendenhall to consider is the impact that benchmarking and relative perform ns to cooperate with one another. Benchmarking one division against another means that a division manager will look good by improvi the performance of the other division manager look bad. cated f control—can cause managers to cut corners and take other actions that boost short-run performance but harm the company in the lo ary and belief systems of control within the company. Strict codes of conduct should govern what employees cannot do. Mendenhall s have a deep belief in the value of the company’s journalistic mission. n diagnostic measures is a myopic disregard for emerging threats and opportunities. Interactive control systems, based on debate and overcome this problem. Mendenhall should not only ask for regular reports on ROI, RI, etc., he should meet regularly with division man ed inputs. Such regular dialogues will help emerging threats and opportunities to surface, as well as the action plans that need to be ta n, levers of control ewards would increase with increases in RI. But compensating managers largely on the basis of RI subjects the r which the manager has no control. A manager may put in a great deal of effort, but the division’s RI may be on uncontrollable risk, Mendenhall must pay them additional amounts within the structure of the RI-based flat salary. The key question is whether the benefits of motivating additional effort justify the higher costs of angements is to balance the benefits of incentives against the extra costs of imposing uncontrollable risk on division’s RI even if taking such actions are not in the best interests of the company as a whole. the company rather than actions that maximize a division’s RI. A negative feature of this arrangement is that e performance of the other division managers. For example, the compensation of Mays, the manager of the over the performance of these divisions. Therefore, compensating managers on the basis of companywide RI the cost of compensating them, on average. s that affect a performance measure. Taking out the effects of these factors provides better information about that similar noncontrollable factors affect each division. It is not clear that the same noncontrollable factors rnet division. If the noncontrollable factors are not the same, then comparing the RI of one division to the RI consider is the impact that benchmarking and relative performance evaluation will have on the incentives for nother means that a division manager will look good by improving his or her own performance, or by making manager look bad. at boost short-run performance but harm the company in the long run. Mendenhall can guard against such nduct should govern what employees cannot do. Mendenhall should also foster a culture where employees any’s journalistic mission. pportunities. Interactive control systems, based on debate and discussion and regular review of strategic orts on ROI, RI, etc., he should meet regularly with division managers, discuss 5- and 10-year strategic plans, unities to surface, as well as the action plans that need to be taken in response. ...
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