Professional Documents
Culture Documents
Prepared by: Hamisah Tahir(2009994473) Farihana Aniza Taha(2009113635) Nurulzia Ibrahim(2009190093) Rahah Adeni(2009782789) Nur Anisaa Safri (2009775685) 2009775685
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Overview
Introduction to financial measures in investment centers Return on Investment (ROI) Residual Income (RI) Measuring performance and invested capital Measures of shareholder value Reward system Performance-related reward system
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Introduction
Financial measures in an investment centre Commonly used to assess the performance of profit centre and investment centre. Focus on profit-based performance measurement for the investment centers 3 types of financial performance measures : Return on investment (ROI) Residual Income (RI) Economic Value Added (EVA)
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Return on Investment
Return on investment (ROI) is a financial measures calculated as profit divided by invested capital. The focus of ROI is not how much profit each investment centre earned, but rather on how well each investment centre used its invested capital to earn a profit. Invested capital the assets that the investment centre has available to generate profit.
ROI =
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ROI (contd)
Example page 657- Rio Tinto Alcan (company which involved in aluminium business )
Operation Profit Invested capital $400 ROI
Refining
$32
Smelting
$48
$800
Components of ROI
ROI = Return on sales X Investment turnover = Return on sales the percentage of each sales dollar that remains as profit after all expenses are covered, calculated as profit divided by sales revenue. Investment turnover the number of sales dollars generated by every dollar of invested capital (assets), calculated as sales revenue divided by invested capital.
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Refining Smelting
32/600=5.3% 48/900=5.3%
600/400=1.5 900/800=1.125
8% 6%
-For refining , Return on sales indicate that for each dollar of sales resulted in about 5 cents profit. Investment turnover 1.50 of sales revenue was generate by each dollar of capital invested. -For Smelting - has an investment turnover on 1.125 which indicates that it is less efficient in its use of assets. -Thus, the utilization of asset that drives the different of ROI, not the profit.. Free Powerpoint Templates Page 7
Advantages of ROI
ROI is used by many decentralized business to evaluate the performance of investment centers. Some of the advantages are : Encourages managers to focus on both profits and assets required to generate those profit. Eg. Discourage excessive investment assets and focus on increasing revenue and reducing cost ROI can be used to evaluate the relative performance of investment centers for both large and small business.
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Disadvantages of ROI
ROI can lead to dysfunctional decision where: It encourage manager to focus on short-term financial performance, at the expense of long term. Eg. Cost-cutting activity could increase ROI but weaken future profits and business future competitiveness likes quality and customer satisfaction. Encourage manager to defer asset replacement and disposal of asset would result increase in ROI. Discourage managers from investing in project that are acceptable from the total organization's Free Powerpoint Templates Page 10 point of view.
Residual Income
The amount of profit that remains(as a residual) after subtracting an imputed interest charge. Where as: =profit (invested capital x imputed interest rate) Unlike ROI, residual income is a dollar amount, not a ratio.
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Residual Income
Imputed interest charge The required rate of return that a company expects of its investments, which is based on the organization cost of capital. Where as: Imputed interest rate = the firms required rate of return
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Advantages of RI
To promote goal congruence compared to ROI Encourages investment in projects which yield a higher residual income to the organization. More flexible because different imputed interest charge can be used for different levels of risk. Takes account of the organization required rate of return in measuring performance.
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Disadvantages of RI
Cannot be used to compare the performance of different-sized business units. Can also encourage a short-term orientation Residual income formula is biased in favour of larger businesses.
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Asset Measurement
Advantages of carrying amount(disadvantages of the acquisition cost) using the carrying amount maintains consistency with the balance sheet using the carrying amount to measure invested capital is also consistent with the definition of profit
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Asset Measurement
Advantages of the acquisition cost (disadvantages of the carrying amount) Selection of a depreciation method(straight-line) is arbitrary which resulting carrying does not provide a reliable measure Depreciating non-current assets may provide a disincentive to invest in new equipment.
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Asset Measurement
Profit margin controllable by the investment centre manager Suitable profit measure if the focus is to measure the performance of the manager of the investment centre. To encourage goal-congruent behavior Profit margin attributable to the investment centre Used to calculate the investment centre ROI or residual income.
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4 aspect of VBM:
i. Valuation
The common method are used to measure value is using the Discounted Cash Flow (DCF) model.
By using this method, the investors and the capital market usually value a business based on the discounted future cash flows of the business. To increase the value of the firm, managers should know and understand the driver of value which is spread, growth, sustainability and the cost of capital. Powerpoint Templates Free
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calculated as the PV of the future Cash Flow plus the Residual Value (RV) of the business. The RV of the business is the value of the company at the end of the forecast period. Here, WACC are used.
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Reward system
Reward system Process, practices & systems that are used to provide levels of pay and benefits to employee
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Motivation
Process that account for an individuals intensity, direction & persistence of effort towards attaining goals. Intrinsic motivation derives from interest & enjoyment of the work Extrinsic motivation derives from sources outside of the individual.
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Theories of motivation
Herzbergs two-factor theory intrinsically rewarding Hygiene factors factors that provide the necessary setting for motivation but do not themselves motivate employees. Egg: working condition, wage levels Motivators factors that related to job content or outcomes of the job that will encourage motivation. Eg:recognition, achievement, nature of work
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Expectancy theory
State that employee motivation is a function of the strength of expectancy, instrumentality and valence. Expectancy (effort performance) Instrumentality (performance reward) Valence (reward personal goal)
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Expectancy theory suggest that individuals will be motivated to perform when they perceive a close linkage between their effort with high level of expectancy, with high instrumentality and with high valence. Herzbergs theory suggest that it is not hygiene factors but factors such as achievement, recognition & responsibility that are strong motivators.
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