© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 25-1 REWARDING BUSINESS PERFORMANCE Chapte r 25
Dec 18, 2015
© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin
25-1
REWARDING BUSINESS PERFORMANCE
Chapter
25
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25-2
Goal Congruence
Alignment of employeegoals and objectiveswith organizational
goals and objectives.
Motivation and AligningGoals and Objectives
Motivation and AligningGoals and Objectives
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Motivation and AligningGoals and Objectives
Motivation and AligningGoals and Objectives
Feedback Steer employees toward goals. Measure progress in achieving goals.
Measureperformance.
Improveperformance.
Rewardperformance.
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Return on investment is the ratio ofprofit to the average investment used
to generate the profit.
Return on investment is the ratio ofprofit to the average investment used
to generate the profit.
Return on Investment (ROI)Return on Investment (ROI)
ROI = Profit Average investment
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SalesAverage Investment
ROI = Profit
Average Investment
ROI = ProfitSales ×
Return on Investment (ROI)Return on Investment (ROI)
Returnon Sales
Returnon Sales
CapitalTurnover
CapitalTurnover
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Return on Investment (ROI)Return on Investment (ROI)
Holly Company reports the following:
Profit $ 30,000
Sales $ 500,000
Average Investment $ 200,000
Holly Company reports the following:
Profit $ 30,000
Sales $ 500,000
Average Investment $ 200,000
Let’s calculate ROI.Let’s calculate ROI.
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Return on Investment (ROI)Return on Investment (ROI)
SalesAverage InvestmentROI =
ProfitSales ×
ROI = 6% × 2.5 = 15%
$500,000$200,000
ROI = $30,000
$500,000 ×
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Three ways to improve ROI
Increase Sales Prices
Decrease Expenses
Lower Invested Capital
Improving ROIImproving ROI
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Improving ROIImproving ROI
Holly’s manager was able to increasesales revenue to $600,000 whichincreased income to $42,000.
There was no change in invested capital.
Holly’s manager was able to increasesales revenue to $600,000 whichincreased income to $42,000.
There was no change in invested capital.
Let’s calculate the new ROI.Let’s calculate the new ROI.
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Improving ROIImproving ROI
SalesAverage InvestmentROI =
ProfitSales ×
Holly increased ROI from 15% to 21%.
ROI = 7% × 3.0 = 21%
$600,000$200,000
ROI = $42,000
$600,000 ×
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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 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 As division manager would you invest in this project?invest in this project?
Criticisms of ROICriticisms of ROI
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As division manager,I wouldn’t invest in
that project becauseit would lower my pay!
Criticisms of ROICriticisms of ROI
Gee . . .I thought we were
supposed to do what was best for the
company!
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Operating Earnings– Investment charge = Residual income
Investment capital× Minimum return = Investment charge
Investment center’sminimum acceptable
return
Residual IncomeResidual Income
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Residual IncomeResidual 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.
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.Let’s calculate residual income.
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Residual IncomeResidual Income
Operating Earnings = $25,000– Investment charge = 20,000 = Residual income = $ 5,000
Investment capital = $100,000× Minimum return = × 20%= Investment charge = $ 20,000
Investment center’sminimum acceptable
return
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Residual IncomeResidual 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?
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?
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Residual income encourages managers to make profitable investments that would
be rejected by managers using ROI.
Residual IncomeResidual Income
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Economic value added tells us how much shareholder wealth is being created.
Economic Value AddedEconomic Value Added
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Economic Value AddedEconomic Value Added
Economic value addedEconomic value added is the annual after-tax operating profit minus the total annual cost of capital.
Cost of capitalCost of capital is weighted-average after-taxcost of long-term borrowing and the cost of debt.
DebtEquity
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After-tax Operating Income– Investment charge = Economic value added
(Total assets – current liabilities)× Weighted-average cost of capital= Investment charge
After-tax cost oflong-term borrowing
and the cost of equity
Economic Value AddedEconomic Value Added
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Economic Value AddedEconomic 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.
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.
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A set of performance targets and results that show an organization’s performance in meeting its responsibilities to various
stakeholders.
A set of performance targets and results that show an organization’s performance in meeting its responsibilities to various
stakeholders.
EmployeeEmployeeStakeholderStakeholder
GroupGroup
InvestorInvestorStakeholderStakeholder
GroupGroup
Balanced ScorecardBalanced Scorecard
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Financial PerspectiveHow do we look
to the firm’s owners?
Learning and Growth Perspective
How can we continuallyimprove and create value?
Business ProcessPerspective
In which activities must we excel?
Customer PerspectiveHow do our
customers see us?
Balanced ScorecardBalanced Scorecard
Visionand
Strategy
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Components of Management Compensation
Components of Management Compensation
I prefer a fixed salaryso 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.
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Design Choices for Management Compensation
Design Choices for Management Compensation
Should we rewardcurrent performance or
future performance?
Should we rewardcurrent performance or
future performance?
Should our rewards be based on accounting
numbers or stock price performance?
Should our rewards be based on accounting
numbers or stock price performance?
Should bonuses befixed or should they
vary with aperformance measure?
Should bonuses befixed or should they
vary with aperformance measure?
Should bonuses bebased on local or
company-wideperformance?
Should bonuses bebased on local or
company-wideperformance?
Should teams ofemployees share bonuses
equally or should theybe in competition?
Should teams ofemployees share bonuses
equally or should theybe in competition?
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End of Chapter 25End of Chapter 25