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PERFORMANCE MEASURES AND MULTINATIONAL CONSIDERATIONS

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Presentation on theme: "PERFORMANCE MEASURES AND MULTINATIONAL CONSIDERATIONS"— Presentation transcript:

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


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