1. PERFORMANCE MEASURES AND MULTINATIONAL CONSIDERATIONS
CHAPTER 23

2. DECENTRALIZATION AND SEGMENTAL REPORTING
COST CENTER
MANAGEMENT IS RESPONSIBLE FOR COSTS BUT NOT REVENUE
PROFIT CENTER
MANAGEMENT IS RESPONSIBLE FOR REVENUES AND COSTS, i.e., PROFITS
INVESTMENT CENTER
MANAGEMENT IS RESPONSIBLE FOR ALL ASPECTS OF THE BUSINESS

3. PURPOSE
TO EVALUATE MANAGEMENT’S PERFORMANCE

4. EVALUATING COST CENTERS
Compare the actual results with budgeted results or, more appropriately, compare the actual results with the amount you think they should be, given what you now know.

5. EVALUATING PROFIT CENTERS
Compare the actual results with budgeted results or, more appropriately, compare the actual results with the amount you think they should be, given what you now know.

6. INVESTMENT CENTERS EVALUATION OF THE TOP MANAGEMENT OF A BUSINESS.
INCLUDES LOANS, STOCK SALES, ETC.

7. EVALUATING PROFIT CENTERS
Profit centers are preferred where the establishment of profit centers is reasonable. Profit centers net revenues against costs. There are generally four methods to evaluate profit centers.
PROFIT
RETURN ON INVESTMENT (ROI)
RESIDUAL INCOME (RI)
ECONOMIC VALUE ADDED (EVA)

8. PROFIT
Simple to apply and information is available. The method simply looks at the profit of the business.
The business, or segment, with the highest profit is judged best.
This method disregards the amount of the investment.
There will be a tendency to seek approval for investment in anything that has a profit.

9. RETURN ON INVESTMENTS (ROI) Same as the accrual rate of return that we covered in Capital Budgeting LET INVESTMENTS = ASSETS
Return on Revenue = Profit/Revenue
Investment Turnover = Revenue/Investment
Return on Investment =
Return on Revenue X Investment turnover

10. RETURN ON INVESTMENT EXAMPLE
PROFIT = $100,000
REVENUE = $1,200,000
INVESTMENTS = $800,000
Return on revenue = $100,000/$1,200,000 =
Investment turnover = $1,200,000/$800,000 = 1.5
Return on Investments = X 1.5
= 0.125

11. Stockholder’s Return on Investment
RETURN ON STOCKHOLDERS EQUITY IS
ROI X
INVESTMENTS
STOCKHOLDERS’ EQUITY

12. ALTERNATIVE CALCULATION
In the calculation of return on assets or on return on investment, we could use ending balances, beginning balances, or an average.

13. OBSERVATIONS ON ROA/I Generally understood.
May encourage managers to not propose investments that would be profitable but would reduce the return on assets (investment) of the division/company. For example, assume a division is earning 25% on assets and has an opportunity to expand with a 20% rate of return. The funds to invest can be obtained at 10%. The expansion would reduce the division’s return on assets.
Rate or return is not as important as amount earned.

14. RESIDUAL INCOME
Considers the cost of capital in the measurement of profit.
Subtract from income the cost of capital.
Income can be before taxes or after taxes
The cost of capital is Investment X Desired Rate of Return

15. RESIDUAL INCOME EXAMPLE
PROFIT = $100,000
ASSETS = $800,000
DESIRED RATE OF RETURN = 9%
RESIDUAL INCOME =
$100,000 - ($800,000 x 0.09) =$28,000

16. EXERCISE 1 RIJEKA COMPANY INCOME = $100,000 ASSETS = $500,000
DESIRED RATE OF RETURN = 10%
CALCULATE THE RETURN ON ASSETS
$100,000/$500,000 = 0.20
CALCULATE RESIDUAL INCOME
$100,000 - ($500,000 X 0.10) =$ 50,000

17. EXERCISE 2 DUBROVNIK COMPANY INCOME = $150,000 ASSETS = $800,000
DESIRED RATE OF RETURN = 10%
CALCULATE THE RETURN ON ASSETS
$150,000/$800,000 =
CALCULATE RESIDUAL INCOME
$150,000 - ($800,000 X 0.10) = $70,000

18. EXERCISE 3 OPATIA COMPANY INCOME = $180,000 ASSETS = $1,200,000
DESIRED RATE OF RETURN = 10%
CALCULATE THE RETURN ON ASSETS
$180,000/$1,200,000 = 0.15
CALCULATE RESIDUAL INCOME
$180,000 - ($1,200,000 X 0.10) = $60,000

19. EXERCISE 4 COMPARE THE THREE COMPANIES RIJEKA DUBROVNIK OPATIA
INCOME $100,000 $150,000 $180,000
ROA
RI $50,000 $70,000 $60,000
RANK THE THREE COMPANIES ON PERFORMANCE.

20. RANKING
RIJEKA DUBROVNIK OPATIA
INCOME
ROA RI

21. ECONOMIC VALUE ADDED (EVA)
THIS IS AN EXTENSION (or subset) OF THE RESIDUAL INCOME METHOD
INCOME IS AFTER-TAX INCOME,
INVESTMENT IS:
TOTAL ASSETS – CURRENT LIABILITIES
COST OF CAPITAL IS THE WEIGHTED AVERAGE COST OF CAPITAL

22. WEIGHTED AVERAGE COST OF CAPITAL
(DEBT RATE X MV DEBT) + EQUITY RATE X MV EQUITY)
MV DEBT + MV EQUITY

23. WHAT VALUES TO USE FOR ASSETS
ORIGINAL COSTS
CURRENT COSTS
GROSS ASSET VALUE
NET BOOK VALUE

24. TIME PERIOD SHOULD ONE USE: SHORT-TERM, ONE YEAR or
LONG-TERM, MORE THAN ONE YEAR

25. PERFORMANCE MEASURES IN MULTI-NATIONALS
ROI
SHOULD IT BE CALCULATED ON THE BASIS OF US DOLLARS OR THE FOREIGN CURRENCY? IF IN US DOLLARS THEN WE NEED TO DETERMINE AN EXCHANGE RATE RI
SHOULD BE IN US DOLLARS BUT THE ASSETS MUST BE ADJUSTED AT SOME EXCHANGE RATE

26. WHAT EXCHANGE RATE TO USE
HISTORICAL RATE
CURRENT EXCHANGE RATE
AVERAGE EXCHANGE RATE