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Unformatted text preview: Chapter 19 - Strategic Performance Measurement: Investment Centers CHAPTER 19: STRATEGIC PERFORMANCE MEASUREMENT: INVESTMENT CENTERS QUESTIONS 19-1 Investment centers are commonly used when there are a number of business units to be compared, and/or when top management intends to evaluate the economic performance of the business unit relative to alternative investments. By definition, managers of these business units exercise control over revenues, costs, and the level of investment in the business unit. The profit per dollar invested (usually called the return) can be compared to the rate of return for alternative investments other types of business units or other investment possibilities. Commonly, the rate of return is determined by taking the ratio of the amount of profit divided by the amount invested in the business unit . 19-2 The three most common financial-evaluation measures for investment centers are: return on investment (ROI), residual income (RI), and economic value added (EVA). 19-3 Return on investment (ROI) is the ratio of some measure of profit to some measure of invested capital for the business unit. 19-4 The primary measurement issues for ROI are: 1. The effect of accounting policies, which affect the determination of income. 2. Other measurement issues for income, which include the handling of non- recurring items in the income statement, differences in the effect of income taxes across units, differential effect of foreign currency exchange, and the effect of cost allocation when two or more units share a facility or cost. 3. Measuring investment: which assets to include? 4. Measuring investment: whether and how to allocate the cost of shared assets. 19-5 The primary advantages of using return on investment (ROI) as a performance indicator are: 1. It is intuitive and easily understood. 2. It provides a useful basis for comparison among SBUs. 3. It is widely used. The primary limitations of return on investment (ROI) as a performance indicator are: 1. It has an excessive short-term focus. 2. Investment planning uses discounted cash flow (DCF) analysis (Chapter 12), while managers are evaluated on ROI. 3. It contains a disincentive for new investment by the most profitable units. 19-1 Chapter 19 - Strategic Performance Measurement: Investment Centers 19-6 The arms-length standard says that transfer prices should be set so they reflect the price that would have been set by unrelated parties acting independently. It is used to set transfer prices on global business such that the countries affected will accept the cost and revenue information for tax and customs purposes. 19-7 We can enhance the ROI measures usefulness by making it the product of two ratios: Assets Sales x Sales ofit Pr ROI = ROI = Return on Sales x Asset Turnover Return on sales (ROS) is the firms profit per sales dollar and it measures the unit managers ability to control expenses and increase revenues to improve...
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- Winter '12