Lecture 5 - Investment centres Flashcards
(!) Describe investment centres in general
General:
- Input: Monetary terms
- Output: Monetary terms
- Incl. Investment level
- Local managers responsible
- Highest level of responsibility
- Value creation: Stakeholder maximization
- Market values in focus
- Focus on financial perspective: Anti metaphysical measures
- Measures must be reliable & congruent
- ROI, ROCE & EVA typically used
Situations:
- Fit new geografical market
- LT focus
- Stable environment
- Depend on mentality
(!) Describe market values
General:
- Benchmarks
- Return must exceed competitor
- Incl. congruence failure: Market dont know firms plans
- Questionable feasibiility
- Asses value changes of firm
- Eg. Stock market
Pros:
- Cost effective: No measurement req.
- More precise, accurate & objective
- Less systematic biases
Limitations:
- Lack controllability. Eg. recession
- Not best proxy: No full info
- Only expectation
- Individual performance not directly reflected
- Lack many measurement criterions
(!) Describe benefits and considerations on accounting measures
Advantages:
- Reliable
- Understandable
- Better LT: Lagging indicator
- Timely
- Accuracy
- Cost effective: By law
- Feasible
Considerations:
- Depend on firm situ: Not start-ups & most R&D
- Rigid: Many rules & laws
- Measurement congruence increase over LC
- Intangibles: Difficult to estimate & evaluate. Eg. Patents
- Focus on past
- Dependent on method
- Conservatively biased: Recognize gain slow, losses quick
- Reflect cost of borrowed capital, ignore cost of equity capital
- Economic value > Book value: Yet difficult estimation of CF
(!) Describe the financial measures of performance in general
General:
- To justify investments
- Try estimate accurate FCF
- Try reduce working capital: Accounts receivable & inventory
- Measures influence DM
- Influenceable > Controllable
- Budgets & forecast not the same: Past & future
- Use actual vs. budgeted amount
- ROIC should exceed COC
- Sunk costs not incl.
Measures:
- ROI
- EVA
Considerations:
- Past > future performance
- RC & manager measured together: Always succesful looking manager
- Degree of influence
Dysfunctional behavior:
- Accounting is incomplete
- Historical vs. Fair value
- Measurement noise
- ST thinking
- Risk data manipulation
(!) Describe the financial measure: ROI & its pros & cons
General:
- Org. use of capital
- Risk under-investment
- Ratio
Advantages:
- High autonomy
- Convenient
- Popular
- Comparable
- Dupont Pyramid
Disadvantages:
- Reject investment w. lower than division ROI despite above COC
- ST thinking
- Dont account for risk or development stage
- Risk suboptimization
- Often overstated if NPV: Assets not same value anymore
- Incentive to lease iso. buying assets
- Risk scrapping usable assets
(!) Describe the financial measure: EVA & its pros & cons
General:
- Numeric value
- Use RI + risk-adjusted WACC
- Build on CAPM & WACC
- Shareholder view
- Charge for capital employed
- Correlate more w. share price
- Sometimes not positive despite positive NPV
- Build on GAAP: Accounting principles
- Since needed estimate on COC
- Since cost of equity recognition
- Very popular
- Eg. ROA & EVA
___________
Advantages:
- High autonomy
- More flexible than ROI
- Instruct divison manager
- Accept investment w. Return > WACC
- Can use diff. ratios of WACC: Eg. Risk or borrowing cash
- Show absolute result of investment
- Reduce incentive to leverage: Debt financing
Disadvantages
- Difficult comparison
- Less understandable
- Hard to estimate WACC
- ST thinking: Shareholder focus
- Increase risk
- Objectivity problems: Judgement & bias
- Still problem if based on BV: Scrap good investment
(?) Make the calculations:
Return on investments:
- ROI = EBIT/Investment
- Net income / Investment
- Percentage
Return on assets:
- ROA = EBIT / Total assets
- Percentage
Return on capital employed:
- ROCE = EBIT/Capital employed
- Capital employed = Total assets - Current liabilities
- Percentage
Economic value added:
- EVA = EBIT - WACC * Investment
- WACC = Weighted average cost of capital
- WACC = Cost of debt% * (Debt/Total capital) + Cost of equity% * (Equity/Total capital)
- Beta = Systematic risk of investment
Describe expenses vs. capitalization
General:
- Expense = P/L
- Capitalized: BS
- Straight line depreciation twist ROI & EVA
- ROI & EVA must be adjusted
- ROI & EVA depend on expenses capitalized or written of immediately
- EVA & ROI smaller initially if many expenditures: Eg. Marketing
- EVA & ROI more steady if capitalized
Intangibles:
- Expenses
- Affect ST earnings
- Not capitalized
Assets:
- Capitalized
- Expensed right away
Describe conderations when across borders
General:
- Comparability of measures
Strategic & organisational dimensions
- Org. structure
- Functional dev.
- Distribution channels
- Tech & work force
- Mission
- Stage of business dev.
Financial dimensions. Internal and external:
- Market price structure
- Cost structure
- Imposed conditions: HQ
- Capital structure & financing methods
- Growth rate
- Inflation rate
Society dimensions:
- Society norms & attitudes
- Regulation: Ecological, health & safety
Relate ROI & EVA to NPV
ROI & EVA:
- Evaluate manager performance: Accountability
- Motivate managers to suggest investments
- Apply accounting period data
NPV:
- Valuate projects: DM
- Works on non-accounting period data
- Can be done systematically
- Added to accounting data: ROI & EVA
(!) Describe some supplements to ROI & EVA
Non-financial measurement:
- Eg. Customer satisfaction
Action control:
- Strategic planning: Beliefs & boundary systems
- Long range budgeting
- DM tools: NPV
Budgeting:
- Budgets
- Budget control
Communication:
- Principal agency theory
- Numbers at face value
Pragmatic constructivism:
- People control
- Management narratives: Eg. Business model
- Learning theory of truth: Pro-active & pragmatic truth
- Trust building
(?) Describe the difference between conservative & liberate accounting policies
General:
- We seek as short lifetime as poss.: Ref. Financial crisis
- We dont want to write things up to early
Conservative:
- Delay recognized revenue
- Delay accelerating expenses or losses
- Profit reported later
Liberale:
