Chapter 23 & 22 - Division Performance Measurement & Transfer Pricing

Chapter 23 & 22 - Division Performance Measurement & Transfer Pricing

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Chapter 23 – Pgs. 801-810 I. Choosing Among Different Performance Measures: Step 1 a. Return on Investment i. ROI = Income/Investment 1. Investment refers to the resources or assets used to generate income ii. Most popular approach to measure performance for two reasons 1. It blends all the ingredients of profitability—revenues, costs, and investment —into a single percentage 2. It can be compared with the rate of return on opportunities elsewhere, inside or outside the company iii. Increase ROI by increasing revenues or decreasing costs (both of which increase the numerator), or by decreasing investment (which decreases the denominator) iv. ROI can provide more insight into performance when it is represented as two components: 1. Income/Investment = Income/Revenues * Revenues/Investment a. ROI = Return on Sales * Investment Turnover i. Known as the DuPont method of profitability analysis b. Residual Income i. Accounting measure of income minus a dollar amount for required return on an accounting measure of investment 1. RI = Income - (Required Rate of Return * Investment) a. Required rate of return multiplied by the investment is the imputed cost of the investment i. Imputed Costs: 1. Costs recognized in particular situations but not incorporated in financial accounting records ii. Some companies favor the RI measure because managers will concentrate on maximizing an absolute amount, such as dollars of RI, rather than a percentage, such as ROI
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
1. Objective of maximizing ROI may induce managers of highly profitable subunits to reject projects that, from the viewpoint of the company as a whole, should be accepted iii. Goal congruence is more likely using RI rather than ROI as a measure of the subunit manager’s performance c. Economic Value Added i. Specific type of RI calculation 1. Equals after-tax operating income minus the (after-tax) weighted-average cost of capital multiplied by total assets minus current liabilities a. EVA = After-Tax Operating Income – [Weighted Average Cost of Capital * (Total Assets – Current Liabilities)] ii. EVA, like RI, charges managers for the cost of their investments in long-term assets and working capital 1. Value is created only if after-tax operating income exceeds the cost of investing the capital a. To improve EVA, managers can i. Earn more after-tax operating income with the same capital
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 6

Chapter 23 & 22 - Division Performance Measurement & Transfer Pricing

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online