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Whbm24 Whbm24 Presentation Transcript

  • Chapter 24 McGraw-Hill/Irwin Rewarding Business Performance © The McGraw-Hill Companies, Inc., 2002
  • Motivation and Aligning Motivation and Aligning Goals and Objectives Goals and Objectives Goal Congruence Alignment of employee goals and objectives with organizational goals and objectives. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Motivation and Aligning Motivation and Aligning Goals and Objectives Goals and Objectives Measure performance. Feedback  Steer employees toward goals.  Measure progress in achieving goals. Improve performance. McGraw-Hill/Irwin Reward performance. © The McGraw-Hill Companies, Inc., 2002
  • Return on Investment (ROI) Return on Investment (ROI) Return on investment is the ratio of profit to the average investment used to generate the profit. ROI = McGraw-Hill/Irwin Profit Average investment © The McGraw-Hill Companies, Inc., 2002
  • Return on Investment (ROI) Return on Investment (ROI) Profit ROI = Average Investment ROI = Profit Sales Return Return on Sales on Sales McGraw-Hill/Irwin × Sales Average Investment Capital Capital Turnover Turnover © The McGraw-Hill Companies, Inc., 2002
  • Return on Investment (ROI) Return on Investment (ROI) Holly Company reports the following: Profit Sales Average Investment $ 30,000 $ 500,000 $ 200,000 Let’s calculate ROI. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Return on Investment (ROI) Return on Investment (ROI) ROI = Profit Sales × $30,000 ROI = × $500,000 Sales Average Investment $500,000 $200,000 ROI = 6% × 2.5 = 15% McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Improving ROI Improving ROI  Decrease Expenses  Increase Sales Prices  Lower Invested Capital Three ways to improve ROI McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Improving ROI Improving ROI Holly’s manager was able to increase sales revenue to $600,000 which increased income to $42,000. There was no change in invested capital. Let’s calculate the new ROI. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Improving ROI Improving ROI ROI = Profit Sales × $42,000 ROI = × $600,000 Sales Average Investment $600,000 $200,000 ROI = 7% × 3.0 = 21% Holly increased ROI from 15% to 21%. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Criticisms of ROI Criticisms of ROI  As division manager at Winston, Inc., your compensation package includes a salary plus bonus based on your division’s ROI -- the higher your ROI, the bigger your bonus.  The company requires an ROI of 15% on all new investments -- your division has been producing an ROI of 30%.  You have an opportunity to invest in a new project that will produce an ROI of 25%. As division manager would you invest in this project? McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Criticisms of ROI Criticisms of ROI Gee . . . I thought we were supposed to do what was best for the company! McGraw-Hill/Irwin As division manager, I wouldn’t invest in that project because it would lower my pay! © The McGraw-Hill Companies, Inc., 2002
  • Residual Income Residual Income Operating Earnings – Investment charge = Residual income Investment capital × Minimum return = Investment charge Investment center’s minimum acceptable return McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Residual Income Residual Income Flower Co. has an opportunity to invest $100,000 in a project that will earn $25,000. Flower Co. has a 20 percent minimum acceptable rate of return and a 30 percent ROI on existing business. Let’s calculate residual income. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Residual Income Residual Income Operating Earnings = $25,000 – Investment charge = 20,000 = Residual income = $ 5,000 Investment capital × Minimum return = Investment charge = $100,000 = × 20% = $ 20,000 Investment center’s minimum acceptable return McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Residual Income Residual Income As a manager at Flower Co., would you invest the $100,000 if you were evaluated using residual income? Would your decision be different if you were evaluated using ROI? McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Residual Income Residual Income Residual income encourages managers to make profitable investments that would be rejected by managers using ROI. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Economic Value Added Economic Value Added Economic value added tells us how much shareholder wealth is being created. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Economic Value Added Economic Value Added Economic value added is the annual after-tax operating profit minus the total annual cost of capital. Cost of capital is weighted-average after-tax cost of long-term borrowing and the cost of debt. Equity McGraw-Hill/Irwin Debt © The McGraw-Hill Companies, Inc., 2002
  • Residual Income Residual Income After-tax Operating Income – Investment charge = Economic value added (Total assets – current liabilities) × Weighted-average cost of capital = Investment charge After-tax cost of long-term borrowing and the cost of equity McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Economic Value Added Economic Value Added Economic value added can be improved in three ways . . .  Increase profit without using more capital.  Use less capital to earn the same amount of profit.  Invest capital in high-return projects. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Balanced Scorecard Balanced Scorecard A set of performance targets and results that show an organization’s performance in meeting its responsibilities to various stakeholders. Employee Investor Stakeholder Stakeholder Group Group McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Balanced Scorecard Balanced Scorecard Financial Perspective How do we look to the firm’s owners? Learning and Growth Perspective How can we continually improve and create value? Vision and Strategy Business Process Perspective In which activities must we excel? Customer Perspective How do our customers see us? McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Components of Management Components of Management Compensation Compensation I prefer a fixed salary so that I know what I will be paid each year. I prefer a bonus arrangement that gives me the opportunity to earn larger amounts. I don’t mind the varying compensation. I like both profit sharing and stock options. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Design Choices for Design Choices for Management Compensation Management Compensation Should we reward Should we reward current performance or current performance or future performance? future performance? Should teams of Should teams of employees share bonuses employees share bonuses equally or should they equally or should they be in competition? be in competition? Should our rewards be Should our rewards be based on accounting based on accounting numbers or stock numbers or stock price performance? price performance? McGraw-Hill/Irwin Should bonuses be Should bonuses be fixed or should they fixed or should they vary with a vary with a performance measure? performance measure? Should bonuses be Should bonuses be based on local or based on local or company-wide company-wide performance? performance? © The McGraw-Hill Companies, Inc., 2002
  • End of Chapter 24 End of Chapter 24 My performance was magnificent! McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002