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12 Cards in this Set
- Front
- Back
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Investment Base |
The sum of the assets employed in an investment center |
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2 Methods for Relating Profit to the Investment Base |
1. The percentage return on investment (ROI) 2. Economic Value Added (EVA) aka Residual Income |
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Purpose of Measuring Assets employed (2) |
*to provide info that is useful for decision making about assets employed & to motivate mgrs to make these decisions in the best interest of the company *to measure the performance of the bus. unit as an economic entity |
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Return on Investment (ROI) |
a ratio, the numerator is income, as reported on the income statement and the denominator is assets employed |
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Economic Value Added (EVA) |
a dollar amount, found by subtracting a capital charge from the net operating profit, to see if there is an increase in value |
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Assets Employed that will be Measured |
Cash, Receivables, Inventories, Working Capital in General, PPE |
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Headquarters asks 2 Questions to decide what investment base to use to eval investment center mgrs |
1. what practices will induce bus. unit mgrs 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? |
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How companies control... 1. Cash 2.Receivables 3. Inventories 4. Working Capital 5. PPE |
1. Controlled centrally 2. bus. unit mgrs influence indirectly, recorded at end of period amounts 3. Same as #2 4. Varies: record only current assets or current assets offset by current liabs 5. recorded at acquisition cost and depr |
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Problems with Annuity Depreciation |
1. Cash Flows could be different than est. 2. Not desirable for income taxes 3. Companies don't use it in their fin reporting |
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Benefits of ROI Measure (3) |
1. comprehensive measure 2. simple to calc, easy to understand, and meaningful in an absolute sense 3. it's a common denominator that may be applied to any org unit responsible for profitability regardless of size (also ROI info avail for compet.) |
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Benefits of EVA (4) |
1. all bus units have the same profit objective for comparable investments 2. decisions that increase a center's ROI may decrease its overall profits 3. diff int rates mat be used for diff types of assets 4. in contrast to ROI, has a stronger positive correlation with changes in a comp's mkt value |
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Actions to increase EVA: (4) |
p. 285 |
