1. Chapter-7
Measuring and Controlling
Assets Employed
Investment center

2. When profit is compared with the assets employed in earning
it, the division is called investment center.

3. Objectives
Provide information that is useful for making sound decision.
To measure the performance of business unit as an economic
entity.
To motivate the managers to make such sound decisions.

4. Focusing on profit without considering the investment will
not serve the purpose.
Unless the amount of assets employed is taken into
consideration, it is difficult for senior management to
compare the profit performance of one business unit with
another.

5. Example
Golden grain, a business unit of Quaker Oats, had very high
profitability and appeared to be one of Quaker Oats’ best
division. It was however acquired by Quaker Oats at a
premium above its book value. Based on the assets employed
as measured by this premium, Golden grain actually was
undertaken.

6. Objectives of business units
They should generate adequate profits out of the resources at
their disposal.
They should invest in additional resources only when the
investment will produce an adequate retun, discounted at the
company’s earning rate.

7. Retun on Investment
ROI is a ratio
The numerator is income as reported on the income
statement.
The denominator is assets employed.

8. Assets Employed= Total Assets- Current liabilities
OR
Non Current Assets+ Working capital

9. Economic Value Added is a dollar amount rather than a
ratio.
It is found by subtracting a capital charge from the net
operating profit.
Coca-Cola, GE and AT&T, employ EVA internally to
measure wealth creation performance.

10. A measure of a company's financial performance based on the
residual wealth calculated by deducting cost of capital from
its operating profit (adjusted for taxes on a cash basis). (Also
referred to as "economic profit".)

11. EVA= Net Operating Profit After Taxes (NOPAT) -
(Capital * Cost of Capital)
This measure was devised by Stern Stewart & Co. Economic
value added attempts to capture the true economic profit of a
company.

12. There are four steps in the calculation of EVA:
1. Calculate (NOPAT)
2. Calculate Total Invested Capital (TC)
3. Determine a Cost of Capital (WACC)
4. Calculate EVA = NOPAT – WACC% * (TC)

13. Example
If Operating Profit= 1,oo,ooo
Total investment=1mn.
ROI= 1,00,000/10,00,000=10%

14. If capital is $100 million - including debt and shareholder
equity - and the cost of using that capital (interest on debt
and the cost of underwriting the equity) is $13 million a
year, it will add economic value for his shareholders only
when profits are more than $13 million a year. If it earns $20
million, the company's EVA will be $7 million.

15. Measuring Assets Employed
What practices will induce business unit managers to use
their assets most efficiently?
What practices best measure the performance of the unit as
an economic entity?

16. Working Capital Component
Cash
Receivables
Inventories
Working capital in general
Property ,Plant and Equipment
Leased Assets
Idle Assets
Intangible Assets

17. Cash
Centralized v/s Decentralized
Higher amountv/s Lower amount

18. Receivables
End of the year balance or Intra period balance
At selling price or at COGS

19. Inventories
End of the period amount v/s Intra period amount
Which method of inventory valuation to be followed

20. Working capital in general
Accounts payable

21. Property ,Plant and Equipment
Acquisition of new Equipment
Gross book value
Disposition of Assets
Annuity Depreciation

22. Acquisition of new Equipment
Business unit that have old almost fully depreciated asset will
tend to report larger economic value added than units that have
newer assets.

23. If depreciable assets are included in the investment base at
net book value, business unit profitability is misstated and
business unit managers may not be motivated to make
correct acquisition decisions.

24. Non Current liabilities
The capital Charge

25. EVA v/s ROI