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EXAM 3 REVIEW - ACC 222 Exam 3 Monday Chapter 12...

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ACC 222 Exam 3 Monday Chapter 12: Performance Evaluation and Decentralization 2 Approaches to Management: - Centralized: decisions are made at the top level - Decentralized: allowing managers at lower levels to make and implement key decisions pertaining to their areas of responsibility Reasons to Decentralize: 1. ease of gathering and using local info 2. focusing on central management 3. training and motivating segment managers 4. enhanced competition Decentralization involves a cost benefit trade off. - Cost: lower level managers are less likely to make decisions that are beneficial to the entire firm value and stock prices, more self interested - Benefit: lower level managers have specific knowledge about how to maximize value Divisions: can be made by product lines or geographical lines Responsibility Centers: a segment of the business whose manager is accountable for specified sets of activities -cost centers - revenue centers - profit centers - investment centers Return on Investment: investment centers are typically evaluated on the basis of return on investment - profit earned per dollar of investment - ROI = - Operating Income refers to earnings BEFORE interest and taxes - Operating Assets are all assets acquired to generate operating income such as cash, receivables, inventories, land buildings, and equipment - AVG Operating Assets = I. Calculate AVG Operating Assets, Margin, Turnover, and ROI a. AVG Operating Assets = b. Margin = Operating Income / Sales - Margin tells how many cents of operating income result from each dollar of sales expressing the portion of sales available for interest taxes and profit c. Turnover = Sales / AVG operating assets - turnover tells how many dollars of sales result from every dollar invested in operating assets, shows how productively assets are being used to generate sales d. ROI = d.i. = Margin * Turnover d.ii. = Operating Income / Average Operating Assets
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d.iii. Advantages of Using ROI – encourages managers to focus on relationship between sales, expenses, and investment; cost efficiency; operating asset efficiency d.iv. Disadvantages of using ROI – can produce a narrow focus on divisional profitability at the expense of the profitability of the overall firm, encourages short run optimization at the expense of the long run II. How to Calculate Residual Income – difference between operating income and the minimum dollar required on a company’s operating assets a. Residual Income = Operating Income – (MIN Rate of Return * AVG Operating assets) b. Residual Income > 0 then the division is earning more than the min required rate of return c. Advantage of Residual Income: encourages managers to accept any project that earns a return that is above the minimum rate d. Disadvantages: may encourage a short run orientation III. How to Calculate Economic Value Added - net income minus total annual cost of capital a. EVA = After tax operating income – (Actual percentage cost of capital * total capital employed) b. EVA > 0 the company has increased its wealth during the period c.
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