# Motorcycle Sales Manager

Document Sample

```					        Chapter 23
Performance Measurement,
Compensation, and Multinational
Considerations
Balanced Scorecard
• In the past we have discussed the fact that the
balanced scorecard is one tool for measuring
performance.
• Many companies use the following measures
in their balanced scorecards:
– Financial perspective
– Customer perspective
– Internal business process perspective
– Learning and growth perspective
Performance measures
• In this chapter we will study several measures
use to evaluate the economic performance of
a company.
– Return on investment
– Residual income
– Economic value added
– Return on sales
Return on Investment (ROI)
• This is the most popular approach to measure
performance.
• The formula is:
Income
ROI 
Investment
ROI Calculation Options
• Some company prefer to use operating
income for the numerator; others prefer to
use after-tax basis net income.
• Some companies use total assets in the
denominator; others prefer to focus only on
those assets financed by long-term debt and
stockholders equity and used total assets
minus current liabilities.
Gaining More Insight through the use
of ROI
• ROI can provide more insight into
performance when it is represented as two
components:
Income    Income    Re venues
         
Investment Re venues Investments

Return on sales    Investment turnover

This approach is known as the DuPont methods of profitability analysis.
Residual Income
• Residual income is an accounting measure of
income minus a dollar amount required return
on an accounting measure of investment.
• The formula is:

Residual Income = Income – (Required rate of return x Investment)

Imputed costs of the investment
Economic Value Added (EVA)
• A more recent measure of economic
performance.
• Formula:

After tax       Weighted
Economic
value added   =   operating
income
-   average
cost of
x
Total
assets   -    Current
liabilities
capital
Return on Sales
• Return on sales is one of the components of
the return on investment in the DuPont
method of profitability analysis.
• Return on sales is calculated by dividing
income by revenues.
Choosing Measurement Alternatives
for Performance Measures
• An important issue to consider is the selection
of the method for measuring assets
investment calculations.
• Should investments be measured at historical
or current cost?
• Should gross book value (original cost) or net
book value (the original cost minus
accumulated depreciation) be used for
depreciable assets?
Additional difficulties created in
analyzing the performance of
multinational companies.
• Economic, legal, political, social, and cultural
environments differ significantly across
countries.
• Some countries limit selling prices and impose
controls on the company’s products.
• Availability of materials and skilled
labor may differ across countries.
Additional difficulties created in
analyzing the performance of
multinational companies.
• Issues of inflation and fluctuation in foreign
currency exchange rates affect performance
measures.
Problem 23-17
• Infotech Systems Inc. has two divisions:
software and services. Results in millions for
the past three years are shown on the
following slide.
• Complete the table by filling in the blanks.
Operating   Operating   Total assets   Operating    Operating      Operating
income     revenues                    income/     revenue/        income/
operating   total assets   total assets
revenues

Software division

2006                    \$340       \$3980          \$960         8.5%

2007                     420                                    10%                          42%

2008                     580                                    11%              5

Services division

2006                    \$310       \$1180          \$640

2007                                1500            900         22%

2008                                              1170                           2           25%

Infotech systems

2006                    \$650      \$5,160         \$1600

2007

2008
Operating   Operating   Total assets   Operating    Operating      Operating
income     revenues                    income/     revenue/        income/
operating   total assets   total assets
revenues

Software division

2006                    \$340       \$3980          \$960         8.5%            4.1         35.4%

2007                    \$420       \$4200         \$1000          10%            4.2           42%

2008                    \$580       \$5273         \$1055          11%              5           55%

Services division

2006                    \$310       \$1180          \$640        26.3%            1.8         48.4%

2007                    \$330       \$1500          \$900          22%            1.7         36.7%

2008                    \$293       \$2340         \$1170        12.5%              2           25%

Infotech systems

2006                    \$650       \$5160         \$1600        12.6%            3.2         40.6%

2007                    \$750       \$5700         \$1900        13.2%              3         39.5%

2008                    \$873       \$7613         \$2225        11.5%            3.4         39.2%
Problem 23-17
• Use the DuPont method to explain changes in
operating-income-to-total assets ratios over
the 2006 through 2008 period for each
division and for Infotech as a whole.
Problem 23-17
• Based on revenues, the software division is
about twice as big as the services division.
• The services division earns higher margins
(operating income as a percent of operating
revenues);
Problem 23-17
• The software division turns over its assets at
more than twice the rate of the services
division (operating revenues as a multiple of
total assets).
Problem 23-17
• The net result is that the ROI of the two
divisions was similar (in the 30–50% range).
• But whereas the ROI of the software division
has been increasing from 2006 to 2008, the
ROI of the services division has been falling.
• Overall, this has resulted in Infotech Systems
showing stable profitability over the past
three years.
Problem 17-19
•   Motorcycle Company.
•   Variable costs = \$1,600/unit
•   Fixed costs = \$24,000,000
•   Investment (total assets) = \$80,000,000
Problem 17-19
• What level of operating income is required to
attain an ROI of 20%?
• ROI = operating income/total assets
• Let X = operating income
• .20 = X/\$80,000,000
• (.20)(\$80,000,000) = X
• X = \$16,000,000
Problem 17-19
• What level of revenues will be needed to
achieve that operating income if Hardy
assembles and sells 100,000 motorcycles?
• Sales – variable costs – fixed costs = operating
income
• Sales – (100,000 x \$1,600) - \$24,000,000 =
\$16,000,000
• Sales = \$200,000,000
Problem 23-19
• What will be the selling price of each
motorcycle?
• \$200,000,000/100,000 = \$2,000
Problem 23-19
• Using the selling price calculated in
requirement 1, what ROI will the company
earn if it sells 150,000 motorcycles?
• (Price x Units Sold) – Variable Costs – Fixed
Costs = Operating Income
• (\$2,000 x 150,000) – (\$1,600 x 150,000) -
\$24,000,000 = \$36,000,000
• Operating Income/Investment = ROI
• \$36,000,000/\$80,000,000 = 45%
Problem 23-19
• Using the selling price calculated in requirement
1, what ROI will the company earn if it sells
50,000 motorcycles?
• (Price x Units Sold) – Variable Costs – Fixed Costs = Operating
Income
• Lets use the contribution margin to shorten the calculation
(\$2,000 revenue - \$1,600 variable cost = \$400 contribution
margin)
• (\$400 x 50,000) - \$24,000,000 = -\$4,000,000 loss
• ROI = -\$4,000,000/\$80,000,000 = 5% negative ROI
Problem 23-19
• The manager is paid a bonus on how much
the actual ROI exceeds the target ROI of 20%.
• Last year with the same cost structure and
selling price, her division manufactured and
sold 150,000 motorcycles compared with
100,000 cycles this year.
Problem 23-19
• Suggest some reasons why she may feel this
bonus plan is not a fair measure of
performance.
Possible Answer
• Lauren Snyder may feel that the measure is
unfair since the ROI is very sensitive to volume
and selling price.
Possible Answer
• If she has no control on the selling price, and
therefore on the demand for Hardy
motorcycles, she may feel that she is being
measured on a factor that is not controllable
by her.
Possible Answer
• It is also unclear how much she can control
costs in the short run.
• It would be better to measure her division's
performance on ROI relative to competitors, if
possible.
Possible Answer
• Also, one year may be too short a time span in
the use of an operating income measure for
gauging performance or for paying bonuses.
Possible Answer
• For instance, motorcycle sales may be heavily
influenced by general economic conditions
that are uncontrollable by the division
managers whose bonuses are significantly
affected thereby.
Possible Answer
• Further, some short-run savings in
manufacturing costs, which may temporarily
boost ROI and bonuses, may have long-run
damaging effects.
• Examples include repairs, maintenance,
quality control, and exerting severe pressures
on employees for productivity.
Problem 23-26
• Dexter Division of AMCO sells car batteries.
• AMCO is considering compensation for the
division manager.
• Proposal 1 = pay a fixed salary.
• Proposal 2 = pay no salary but compensate
him on ROI, calculated on operating income
before payment of bonuses.
• Proposal 3 = pay some salary and some bonus
based on ROI.
Problem 23-26
• Evaluate the three proposals, giving the
advantages and disadvantages of each.
Problem 23-26
• Proposal 1:
• Paying Marks a flat salary will not subject
Marks to any risk, but it will provide no
incentives for Marks to undertake extra
physical and mental effort.
Problem 23-26
• Proposal 2:
• Rewarding Marks only on the basis of Dexter
Division’s ROI would motivate Marks to put in
extra effort to increase ROI because Marks’s
rewards would increase with increases in ROI.
Problem 23-26
• But compensating Marks solely on the basis of
ROI subjects Marks to excessive risk because
the division’s ROI depends not only on Marks’s
effort but also on other random factors over
which Marks has no control.
Problem 23-26
• For example, Marks may put in a great deal of
effort, but, despite this effort, the division's
ROI may be low because of adverse factors
(such as high interest rates or a recession)
which Marks cannot control.
Problem 23-26
• To compensate Marks for taking on
uncontrollable risk, AMCO must pay him
additional amounts within the structure of the
ROI-based arrangement.
• Thus, compensating Marks only on the basis
of performance-based incentives will cost
AMCO more money, on average, than paying
Marks a flat salary. The difference is what we call a risk
premium!
Problem 23-26
• The key question is whether the benefits of
motivating additional effort justify the higher
costs of performance-based rewards.
Problem 23-26
• Furthermore, the objective of maximizing ROI
may induce Marks to reject projects that, from
the viewpoint of the organization as a whole,
should be accepted.
• This would occur for projects that would
reduce Marks’s overall ROI but which would
earn a return greater than the required rate of
return for that project.
Problem 23-26
• Proposal 3:
• The motivation for having some salary and
some performance-based bonus in
compensation arrangements is to balance the
benefits of incentives against the extra costs
of imposing uncontrollable risk on the
manager.
Problem 23-26
• Suppose AMCO competes against Tiara
Industries in the car battery business.
• Tiara is approximately the same size and
operates in a similar business environment as
Dexter.
Question
• Top management is considering evaluating the
manager on the basis of Dexter’s ROI minus
Tiara’s ROI.
• The mangers complains the approach is unfair
because the performance of another company
over which he has control is included in the
performance evaluation measure.
• Is his complaint valid? Why or why not?
Possible Answer
• Marks’s complaint does not appear to be
valid.
• The senior management of AMCO is proposing
to benchmark Marks’s performance using a
relative performance evaluation (RPE) system.
• RPE controls for common uncontrollable
factors that similarly affect the performance of
managers operating in the same environments
(for example, the same industry).
Possible Answer
• If business conditions for car battery
manufacturers are good, all businesses
manufacturing car batteries will probably
perform well.
• A superior indicator of Marks’s performance is
how well Marks performed relative to his
peers.
Possible Answer
• The goal is to filter out the common noise to
get a better understanding of Marks’s
performance.
• Marks’s complaint will be valid only if there
are significant differences in investments,
assets, and the business environment in which
AMCO and Tiara operate.
• Given the information in the problem, this
does not appear to be the case.
Question
• Now suppose the manager has no control
over authority for capital-investment
decisions.
• Corporate management makes these
decisions.
• Is ROI a good performance measure to
evaluate the manager?
Possible Answer
• Superior performance measures change
significantly with the manager's performance
and not very much with changes in factors
that are beyond the manager’s control.
Possible Answer
• If Marks has no authority for making capital
investment decisions, then ROI is not a good
measure of Marks’s performance––it varies
with the actions taken by others rather than
the actions taken by Marks.
• AMCO may wish to evaluate Marks on the
basis of operating income rather than ROI.
Question
• Is ROI a good measure to evaluate the
economic viability of the Dexter Division?
Possible Answer
• ROI may be an inappropriate measure of
Marks’s performance but a reasonable
measure of the economic viability of the
Dexter Division.
Possible Answer
• If, for whatever reasons (bad capital
investments, weak economic conditions, etc.)
the Division shows poor economic
performance as computed by ROI, AMCO
management may decide to shut down the
division even though they may simultaneously
conclude that Marks performed well.
Problem 23-26 Continued
• Dexter’s salespersons are responsible for
selling and providing customer service and
support.
• Sales are easy to measure.
Problem 23-26 Continued
• Although customer service is important to
Dexter in the long run, it has not yet
implemented customer service measures.
• The manager wants to compensate this sales
force only on the basis of sales commissions
paid for each unit of product sold.
Problem 23-26 Continued
• He cites two advantages to this plan:
– It creates strong incentives for the sales force to
work hard.
– The company pays salespersons only when the
company itself is earning revenue.
• Do you like this plan? Why or why not?
Possible Answer
• There are two main concerns with Marks’s
plans.
Possible Answer
• First, creating very strong sales incentives
imposes excessive risk on the sales force
because a salesperson’s performance is
affected not only by his or her own effort, but
also by random factors (such as a recession in
the industry) that are beyond the
salesperson's control.
Possible Answer
• If salespersons are risk averse, the firm will
have to compensate them for bearing this
extra uncontrollable risk.
Possible Answer
• Second, compensating salespersons only on
the basis of sales creates strong incentives to
sell, but may result in lower levels of customer
service and sales support (this was the story at
Sears auto repair shops where a change in the
contractual terms of mechanics to “produce”
more repairs caused unobservable quality to
be negatively affected).
Possible Answer
• Where employees perform multiple tasks, it
may be important to “blunt” incentives on
those aspects of the job that can be measured
well (for example, sales) to try and achieve a
better balance of the two tasks (for example,
sales and customer service and support).
Problem 23-27
• Pike Enterprises has three operating divisions.
• The managers of these divisions are evaluated
on their division operating income, a figure
that includes an allocation of corporate
overhead proportional to the revenues of
each division.
Problem 23-27
• The income statements in thousands for the
first quarter of 2007 are as follows:
Andorian   Orion   Tribble    Pike
Revenues                      \$2000    \$1200   \$1600     \$4800
Cost of goods sold             1050     540       640    2230
Gross margin                    950     660       960    2570
Division overhead               250     125       160     535
Corporate overhead              400     240       320     960
Division operating income      \$300    \$295     \$480     \$1075
Problem 23-27
• John Moore, the manager of the Andorian
Division, is unhappy that his profitability is
about the same as the Orion Division’s and is
much less than the Tribble Division, even
those revenues are much higher than either of
these divisions.
Problem 23-27
• Moore also knows that he is carrying one line
of products with low profitability.
• He was going to replace this line of business as
soon as more profitable product opportunities
became available, but he is It because the line
is marginally profitable and uses facilities that
would otherwise be idle.
Problem 23-27
• More now realizes, however, that the
revenues from the product line are attracting
a large amount of corporate overhead
because of the allocation procedure in use.
Problem 23-27
• This low-margin line of products had the
following characteristics (in thousands) for the
most recent quarter.
– Revenues: \$800
– Cost of goods sold: \$600
– Avoidable division overhead: \$100
Problem 23-27
• Prepare the income statement for Pike
Enterprises for the second quarter of 2007.
• Assumed that revenues and operating results
are identical to the force quarter except that
Moore has discontinued the low margin
product line.
Problem 23-27
Andorian Orion Tribble Total
Net sales                 \$1,200 \$1,200 \$1,600 \$4,000
Cost of sales                 450    540    640 1,630
Divisional overhead           150    125    160    435
Divisional contribution       600    535    800 1,935
Corporate overhead            288    288    384    960
Operating income            \$312   \$247   \$416   \$975

\$2,000 - \$800 = \$1,200

\$1,050 - \$600 = \$450

\$250 - \$100 = \$150

(\$1,200/\$4000) x \$960 = \$288
Problem 23-27
Andorian Orion Tribble Total
Net sales                 \$1,200 \$1,200 \$1,600 \$4,000
Cost of sales                 450    540    640 1,630
Divisional overhead           150    125    160    435
Divisional contribution       600    535    800 1,935
Corporate overhead            288    288    384    960
Operating income            \$312   \$247   \$416   \$975

Is Pike Enterprise better off from discontinuing the low margin
product line?

No, its profits are lower because the low margin product line still
had a positive contribution margin. Regardless of figures like ROI
or income as a percent of sales, more money is still better than
less money!
Problem 23-27
Andorian Orion Tribble Total
Net sales                 \$1,200 \$1,200 \$1,600 \$4,000
Cost of sales                 450    540    640 1,630
Divisional overhead           150    125    160    435
Divisional contribution       600    535    800 1,935
Corporate overhead            288    288    384    960
Operating income            \$312   \$247   \$416   \$975

Is Moore better off from discontinuing the low margin product
line?
Answer
• The Andorian Division manager’s performance
evaluation measure (divisional operating
income) is higher (\$312,000 in the second
quarter versus \$300,000 in the first quarter) as
a result of dropping the low-profitability
product line.
Answer
• The Andorian Division manager is able to
show a \$12,000 higher operating income
because the \$100,000 in lost contribution
margin from the dropped product line is more
than offset by the \$112,000 reduction in
corporate overhead that is charged to the
Andorian Division.
Answer
• Andorian Division sales are now only 30% of
corporate sales rather than the previous
41.7% of sales (so 30% of total corporate
overhead costs of \$960,000 equal to \$288,000
are allocated to the Andorian Division in the
second quarter, whereas 41.7% of \$960,000
equal to \$400,000 were allocated to the
Andorian Division in the first quarter).
Question
• Suggests changes for Pike’s system of division
reporting and evaluation that will motivate
division managers to make decisions that are
in the best interest of the company as a
whole.
• Discuss any potential disadvantages to your
proposal.
Possible Answer
• The easiest solution is not to allocate fixed
corporate overhead to divisions. Then the
problem of dysfunctional behavior will not
arise.
Problem 23-28
• Mineral Waters operates three divisions that
process and bottle sparkling mineral water.
• The historical cost accounting system reports
the following information for 2007.
Accounting Information
Rocky
Calistoga   Alpine Springs   Mountain
Division         Division    Division
Revenues                    \$500,000         \$700,000    \$1,100,000
Operating costs excluding    300,000          380,000      600,000
depreciation
Plant depreciation            70,000          100,000      120,000
Operating income             130,000         \$220,000     \$380,000
Current assets              \$200,000         \$250,000     \$300,000
Long-term assets             140,000          900,000     1,320,000
Total assets                \$340,000       \$1,150,000    \$1,620,000
Problem 23-28
• Mineral Waters estimates the useful life of
each plant to be 12 years, with no terminal
disposal value.
• The straight-line depreciation method is used.
• At the end of 2007, the Calistoga plant is 10
years old, the Alpine Spring plant is 3 years
old, and the Rocky Mountains plant is 1 year
old.
Problem 23-28
• An index of the construction costs over the 10
year period that Mineral Waters has been
operating (1997 year-end = 100) is:

1997       2004       2006       2007
100        136        160        170

Given the high turnover of current assets,
management believes that the historical costs and
current cost measures of current assets are
approximately the same.
Problem 23-28
• Compute the ROI ratio for each division using
historical cost measures. Comment on the
results.
• Calistoga: \$130,000/\$340,000 = 38.24%
• Alpine Springs: \$220,000/\$1,150,000 =
19.13%
• Rocky Mountain: \$380,000/\$1,620,000 =
23.46%
Of course Calistoga has a higher ROI because the denominator (historical
cost assets) is lower. Historical cost isn’t useful for this type of analysis.
Problem 23-28
• Use the approach from page 802 to compute
the ROI of each division, incorporating
current cost estimates as of 2007 for
depreciation expense and long-term assets.
Problem 23-28
• First we must calculate the original cost of
each plant by multiplying the useful life of
each plant (12 years) biannual depreciation.
Calistoga         12  \$70,000 =    \$ 840,000
Alpine Springs    12  \$100,000 =   \$1,200,000
Rocky Mountains   12  \$120,000 =     \$1,440,000
Problem 23-28
• Now we will restate the long-term assets from
gross book value at historical cost to gross
book value at current cost as of the end of
2007.
• We will use this formula for this restatement:
Gross book              Construction Cost Index in 2007
value at       x
historical cost          Construction Cost Index in Year of
Construction
Restated Assets in Gross Book
Value at Current Cost as of the End
of 2007
Calistoga        \$ 840,000  (170 ÷ 100)    = \$1,428,000
Alpine Springs   \$1,200,000  (170 ÷ 136)   = \$1,500,000
Rocky Mountain   \$1,440,000  (170 ÷ 160)   = \$1,530,000
Problem 23-28
• Now we will calculate the net book value of
these assets (after depreciation value) using
the following formula:
Gross book            Estimated Remaining Useful Life
value at     x
current cost at
Estimated Total Useful Life
the end of
2007
Net Book Value at Current Cost
Calistoga            \$1,428,000  (2 ÷ 12) =    \$ 238,000
Alpine Springs       \$1,500,000  (9 ÷ 12) =    \$1,125,000
Rocky Mountains      \$1,530,000  (11 ÷ 12) =   \$1,402,500

Now we will calculate the current cost of total
assets (current assets plus fixed assets) by
totaling these two numbers.
Calistoga          \$200,000 + \$238,000     = \$ 438,000
Alpine Springs     \$250,000 + \$1,125,000   = \$1,375,000
Rocky Mountains    \$300,000 + \$1,402,500   = \$1,702,500
Problem 23-28
• Now we will compute current cost
depreciation expense in 2007 dollars by taking
the gross value of long-term assets at current
cost at the end of 2007 and dividing by 12 (the
estimated life of the assets).
Calistoga                \$1,428,000 ÷ 12 = \$119,000
Alpine Springs           \$1,500,000 ÷ 12 = \$125,000
Rocky Mountains          \$1,530,000 ÷ 12 = \$127,500

Why are we doing this? To “normalize” depreciation so the calculations such
as ROI comparisons are valid (we are comparing apples to apples).
Problem 23-28
• Now we will compute ROI using current cost
estimates for long-term assets and
depreciation expense using the following
formula:
Operating Income for 2007 Using Current
Cost Depreciation Expense in 2007 dollars

Current cost of total assets at the end of 2007

Calistoga               \$ 81,000 ÷ \$ 438,000       = 18.49%
Alpine Springs          \$195,000 ÷ \$1,375,000      = 14.18%
Rocky Mountains         \$372,500 ÷ \$1,702,500      = 21.88%
Problem 23-28
• Okay, now we can compare our ROI
calculations using both asset valuations.

ROI:        ROI:
Historical   Current
Cost        Cost
Calistoga     38.24%      18.49%
Alpine        19.13       14.18
Springs
Rocky         23.46       21.88
Mountains
Problem 23-28
• Which calculations you think are more valid?
• Use of current costs increases the
comparability of ROI measures across
divisions’ operating plants built at different
con-struction cost price levels.
Problem 23-28
• Which calculations you think are more valid?
• Use of current cost also will increase the
willingness of managers, evaluated on the
basis of ROI, to move between divisions with
assets purchased many years ago and
divisions with assets purchased in recent
years.
The End!

```
DOCUMENT INFO
Shared By:
Categories:
Stats:
 views: 12 posted: 4/13/2011 language: English pages: 94
Description: Motorcycle Sales Manager document sample