Chapter 7

MEASURING & CONTROLLING ASSETS EMPLOYED

Structure of the Analysis

The purpose is the same with profit centers. Profit vs Assets Employed. Business unit managers performance objectives:
1.

2.

Generate adequate profits from the resources at their disposal. Invest in additional resources only when the investment will produce adequate return.

Structure of the Analysis

Two ways of relating profit to assets employed:

1.

2.

Return on Investment (ROI) Economic Value Added (EVA)

See exhibit 7.1

Measuring Assets Employed

Decide the investment base. Two questions: 1. What practices will induce business unit managers to use their assets most efficiently & to acquire the proper amount & kind of new assets? 2. What practices best measure the performance of the unit as an economic entity?

Measuring Assets Employed

Cash Receivables Working Capital in General Property, Plant & Equipment Leased Assets Idle Assets Intangible Assets Noncurrent Liabilities The Capital Charge

EVA versus ROI

Benefits of ROI:
1. 2. 3.

A comprehensive measure ROI is simple to calculate. A common denominator that may be applied to any organizational unit responsible for profitability.

EVA versus ROI

EVA benefits over ROI:

1.

2.

3.

4.

All business units have the same profit objective for comparable investment. Decisions that increase a centers ROI may decrease its overall profit. Different interest of rates may be used for different types of assets. EVA has a stronger positive correlation with changes in a companys market value.

EVA versus ROI

Shareholders are important stakeholders in a company. Reasons why shareholder value creation is critical to the firm:
1. 2. 3.

It reduces the risk of takeover. Creates currency for aggressiveness in mergers & acquisitions. Reduces cost of capital, which allows faster investment for future growth.

The best proxy for shareholder value at the business unit level is to ask business unit managers to create & grow EVA.