13 - Performance Evaluation Flashcards
what does PE assess?
an individual/division’s value added to the first
why do we do PE?
- influence their behavior
- performance accountability
- ensure company obj. are met
how does a functional company structure?
groups same activities
how does a divisionalised company structure?
groups the same products
what are the adv. of a divisional structure?
- improves speed/quality of dec-mak
- inc efficiency
- inc motivation
what are the disadv. of a divisional structure?
- lack of goal congruence
- more costly to operate
- loss of control by top mgmt
which measures can we use for performance evaluation?
- net profit
- residual income
- EVA
- return on investment
what do we do with (non-con) head office costs when evaluating a division?
- include if we are comparing to an outside company
- exclude if comparing to another division
why can we not only use net profit as a performance measure?
does not account for risks, controllability and covering the cost of investment
disadv. of using net profit for PE?
- short-term focused
- accounting-based – manipulatable
what is the formula for ROI?
net op profit BIAT / net investment
do we adjust for controllability for ROI?
no, mention in discussion
what is the formula for net inv?
TA - CL
E + l/t L
how do we compare ROI to company ROI?
choose the inv with the higher ROI
what is the formula for residual income?
net op profit BIAT - (WACC x net inv)
(if positive, take inv)
advantages of ROI?
- comparable
- provides info about if value was created, using WACC
disadvantages of ROI?
- doesn’t acc for risk
- uses acc numbers
- does not encourage acceptance of potentially profitable projects
advantages of RI?
- provides info about risks and if value was created, using WACC
- encourages goal congruence
disadvantages of RI?
- encourages inappropriate asset disposal
- increases each year even without any additional value added
- uses acc numbers
what does WACC represent?
the average risk for the entity
what must we consider for company-wide WACC vs divisional WACC?
local and specific risks which differ
what is the formula for EVA?
(NOPBIAT + acc adj) - (WACC x (net inv + acc adj))
why do we do acc adj for EVA?
so that we recognize economic substance rather than accounting form
what accounting adjustments do we make for EVA?
- non-recurring items
- discretionary exp (remove and amortise over period of benefit, balance added to net inv)
- non-op items (both)
what do we do with costs which are avoidable but not controllable?
include for divisions in EVA
