03 Handout 1

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Questions and Answers

What is the average operating assets used to compute ROI for 20X3?

P1,720,000

P2,100,000

P1,910,000 (correct)

P1,800,000

What is the calculated ROI using the basic ROI formula for 20X3?

10.47% (correct)

10.37%

11.00%

9.50%

What does the Dupont formula require to compute the ROI?

Net operating income divided by average operating assets

Profit margin multiplied by asset turnover (correct)

Average operating assets divided by sales

Total sales divided by net operating income

What might a low return on investment indicate regarding a company’s financial performance?

It may be due to low operating income or inefficient asset use. Signup and view all the answers

How is profit margin calculated according to the given content?

Net operating income divided by sales Signup and view all the answers

What can a high return on assets indicate about a company's operations?

The company is utilizing its assets efficiently. Signup and view all the answers

Using the Dupont formula, what is the first step in calculating ROI?

Determine net operating income. Signup and view all the answers

How does a newly purchased expensive machinery relate to ROI in early years?

It may cause a low ROI initially but can be acceptable. Signup and view all the answers

What does positive residual income indicate about a business or investment?

The business is creating value by exceeding its cost of capital Signup and view all the answers

Which of the following accurately defines Net Operating Income?

Profit after all operating expenses, including taxes and interest Signup and view all the answers

Why can't residual income be used to compare investment centers of different sizes?

Bigger centers will show higher net operating and residual incomes without indicating better management Signup and view all the answers

If the Average Operating Assets is $20,000,000 and the Minimum required rate of return is 12%, how much is the cost of capital that needs to be covered?

$2,400,000 Signup and view all the answers

What is the formula for calculating residual income?

Net operating income - (Average Operating Assets X Minimum required rate of return) Signup and view all the answers

What is the Net Operating Income if the EBIT is $2,000,000, interest expense is $700,000, and tax expense is $390,000?

$910,000 Signup and view all the answers

How would you interpret a negative residual income result?

The business is not generating enough profit to cover its cost of capital Signup and view all the answers

What does the term 'Cost of Capital' refer to?

The minimum return that an investor requires for undertaking risk Signup and view all the answers

What could result from a company having a low percentage return on investment compared to industry standards?

The company's equipment may not be used efficiently. Signup and view all the answers

Which factor could be a sign of poor management in relation to return on investment?

Excessive growth leading to an increase in assets without matching revenue. Signup and view all the answers

Why might a manager reject a potentially profitable investment opportunity?

To avoid increasing their performance measurement risk. Signup and view all the answers

How is residual income calculated?

Net Operating Income - (Investment * Cost of Capital) Signup and view all the answers

What is the minimum required return for STI Company?

P2,400,000 Signup and view all the answers

What is a potential downside of a manager striving to increase ROI in the short term?

Long-term growth may be sacrificed. Signup and view all the answers

Which of the following could indicate inefficiency in asset utilization within a business?

High levels of repair and maintenance costs. Signup and view all the answers

What does negative residual income indicate about a company?

The company does not meet its minimum required return. Signup and view all the answers

Which of the following statements about Economic Value Added (EVA) is true?

EVA accounts for opportunity costs. Signup and view all the answers

What might be a consequence of a new manager taking over a segment with many committed costs?

Decreased return on investment performance assessment. Signup and view all the answers

What is one limitation of using ROI as a performance measurement tool?

It may lead to disregarding profitable opportunities. Signup and view all the answers

Implicit costs are best defined as:

Gains that could have been achieved if different decisions were made. Signup and view all the answers

Why do companies use non-financial performance measures?

To assess organizational performance drivers. Signup and view all the answers

In what situation would opportunity costs be relevant?

When considering a make or buy decision. Signup and view all the answers

Which financial measure can help assess which company segment performed better?

Return on Investment (ROI) Signup and view all the answers

What is a limitation of traditional financial assessments like ROI and Residual Income?

They do not account for non-financial performance drivers. Signup and view all the answers

What does MCE represent in the context of production processes?

Value-added time in relation to total time Signup and view all the answers

How does monitoring MCE impact delivery time?

It helps identify non-value-added activities Signup and view all the answers

Which of the following best describes Critical Success Factors (CSF)?

Ingredients necessary for a company to achieve its objectives Signup and view all the answers

What is a common characteristic of operational performance measures?

They vary according to industry standards and critical success factors Signup and view all the answers

What is a potential drawback of relying solely on financial performance indicators?

They may overlook non-financial factors driving success Signup and view all the answers

What role do Key Performance Indicators (KPI) serve in an organization?

They provide a clear indication of performance metrics Signup and view all the answers

In which type of organization can operational performance measures be effectively adopted?

Both manufacturing and service organizations Signup and view all the answers

Why might management consider an output-based approach for performance appraisal?

It emphasizes the quality of work produced Signup and view all the answers

Study Notes

Return on Investment (ROI)

ROI is calculated by dividing Net Operating Income by Average Operating Assets.
Average operating assets are calculated by averaging total assets from the current and prior years.
ROI can also be calculated using the DuPont formula, which multiplies profit margin and asset turnover.
Profit margin is determined by dividing Net Operating Income by Sales.
Asset turnover is calculated by dividing Sales by Average Operating Assets.
Comparing ROI to other companies in the same industry provides a more realistic assessment of financial performance.
A high ROI signifies efficient asset utilization.
A low ROI might not be necessarily negative and could be due to various reasons such as low operating income, inefficient asset use, or poor management.

Limitations of ROI

ROI may be influenced by short-term decision-making that ultimately harms long-term company success.
Committed costs from previous management can distort ROI for new managers, making performance assessment difficult.
Managers may reject profitable investments that could negatively impact their performance evaluations based on ROI.
Residual Income can be used as an alternative approach to measure investment centre performance.

Residual Income

Residual Income is a measure used to evaluate business or investment performance and profitability.
It is calculated as: Net Operating Income - (Investment * Cost of Capital).
Positive residual income indicates value creation by generating more profit than the cost of capital.
Negative residual income suggests insufficient profit to cover the cost of capital.
Residual Income cannot be used to compare performance of investment centres of different sizes due to its formula.

Economic Value Added (EVA)

EVA is considered an improvement over Residual Income as it includes implicit costs such as opportunity costs.
Opportunity costs are potential gains forgone when making a specific business decision.
For example, in a make or buy decision, the opportunity costs represent savings from not incurring manufacturing costs if buying instead.

Operating Performance Measures

Non-financial performance measures are also crucial for evaluating management performance.
While financial measures quantify operational results, they don't directly measure factors driving organizational performance.
For instance, ROI and Residual Income can determine financial performance differences between segments but don't assess the specific targets impacting overall performance.
MCE (Manufacturing Cycle Efficiency) is a key operating measure.
MCE is calculated as the value-added time (processing time) divided by the throughput time.
A high MCE indicates efficient use of time and resources.
Monitoring MCE helps to reduce non-value-added activities, which can ultimately shorten delivery time.
Companies should define Critical Success Factors (CSF), which are crucial for achieving objectives.
CSFs are often measured through Key Performance Indicators (KPIs) which help understand critical aspects for business success.

Performance Appraisal in a Changing Workplace

Traditional performance appraisals often rely on time spent by employees.
Modern businesses are shifting towards output-based evaluations to better assess performance in diverse work arrangements.
Non-financial factors are crucial in determining overall organizational success.

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Description

This quiz covers the calculation of Return on Investment (ROI), including the formula and components involved such as profit margin and asset turnover. It also discusses the significance of comparing ROI within an industry and addresses the limitations of ROI in reflecting long-term company performance.