Divisional Performance Evaluation

Question 1

What are the advantages of divisionalisation?

Answer 1

• Quicker Decisions can be made
• improved quality decisions
• managerial motivation
• top management can devote more time to strategic issues

Question 2

What are the disadvantages of divisionalisation?

Answer 2

• may promote lack of goal congruence
• more costly to operate division structure
• loss of control by top management

Question 3

What are the two performance perspectives we can look at?

Answer 3

• managerial performance
• economic performance

Question 4

What are the tools we can use to measure performance for a managerial performance perspective?

Answer 4

• ROI(Return on Investment) = Divisional Profit / assets employed in the division
• RI (residual income) = controllable contribution - (controllable investment x (cost of Capital))

Question 5

What are the tools we can use to measure performance for a economic performance perspective?

Answer 5

EVA = conventional divisional profit +- Accounting adjustments - (divisional assets * cost of capital %)

Question 6

What are the accounting adjustments that need to be made to the EVA?

Answer 6

• net assets are valued at their replacement costs
• nets are increased by any costs that were capitalized
• research and development expenditure are not seen as expenditure but investments and so they are added back
• any non cash items are removed
• once off unusual items of profit or expenditure are ignored
• interest is excluded because it already taken into account with the capital charge
• accounting depreciation should be reversed and economic depreciation should be considered(added)

Question 7

How do you know what assets should be included in your asset investment item?

Answer 7

Managerial performance - only the assets and liabilities that are within the control of the manager
economical performance - the above and the allocated corporate assets

Question 8

what are the advantages and disadvantages of Residual Income performance Evalution method?

Answer 8

advantages
- ensures goal congruence
- it is more flexbile as it allows different cost of capital percentages to be applied

disadvantages
- difficult to compare performance between divisions
- difficult to decide on an appropriate and accurate measure of capital employed

Question 9

what are the advantages and disadvantages of Return on investment method?

Answer 9

Advantages
- user friendly
- Widely used in practice
- enables a % comparsion
- Provides information on value creation becuase profit relates to investment and compared to the cost of capital

disadvantages
- ignores TVM
- ROI varies depending on your valuation basis for your assets
- ignores any qualitative issues
- won’t work well for service based industries where not a large capital investment is required
- may cause managers to reject positive NPC projects because the ROI is lower than the WACC
- ROI casues short-term focus