Lecture 5 - Financial performance indicators

Question 1

Advantages of a divisional organizational structure:

Answer 1

• Improved quality of decisions
• Quicker decisions
• Increases managerial motivation
• Enables top management to devote more time to strategic issues
• More appropriate for diverse products

Question 2

Disadvantages of a divisional organisation structure:

Answer 2

• Loss of control by top management
• More costly
• May promote a lack of goal congruence
• Sub optimization

Question 3

Return on investment (ROI) is a relative measure of…

Answer 3

Performance that can be compared with other investments

Question 4

Disadvantages of ROI:

Answer 4

• May motivate managers to make decisions that are bad for the company
• May also motivate managers to make incorrect asset disposal decisions

Question 5

Residual income (RI) is calculated by….

Answer 5

Controllable profit less a cost of capital charge on the investment controllable by the manager

Question 6

Advantages of residual income (RI):

Answer 6

-Promotes congruence
-Enables different cost of capital percentages to be
applied to different investments that have different levels of risk

However, RI is not widely used

Question 7

During the 1990’s, RI was renamed to…

Answer 7

Economic value added (EVA)

Question 8

Economic value added (EVA) is calculated by…

Answer 8

Conventional divisional profit based on GAAP + or - Accounting Adjustments - Cost of capital charge on divisional assets

Question 9

Problems with traditional performance indicators include:

Answer 9

• Don’t take a comprehensive view of performance
• Oriented to the past - Not the future
• Focus mainly on outputs
• Focus more on manufacturing and production rather than the lifecycle as a whole
• Short term focused