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Transfer Pricing
ROI, RI, EVA
McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Decentralization
Advantages
Allows organization Uses specialized
to respond more knowledge and
quickly to events. skills of managers.
Income
ROI =
Invested Capital
Sales Capital
Margin Turnover
Return on Investment (ROI)
Income $ 30,000
Sales Revenue $ 500,000
Invested Capital $ 200,000
$30,000 $500,000
ROI = ×
$500,000 $200,000
$42,000 $600,000
ROI = ×
$600,000 $200,000
Investment capital
× Imputed interest rate
= Investment charge
Investment center’s
minimum required
rate of return
Residual Income
Investment center’s
minimum required
rate of return
Residual Income
• As a manager at
Flower Co., would you
invest the $100,000 if
you were evaluated
using residual income?
• Would your decision
be different if you were
evaluated using ROI?
Residual Income
Residual income encourages managers to
make profitable investments that would
be rejected by managers using ROI.
Economic Value Added
Economic value added tells us how much
shareholder wealth is being created.
Economic Value Added
Investment center’s after-tax operating income
– Investment charge
= Economic Value Added