CHEETAH DIVISION Elvira & Van March 16, 2004 Cheetah ROI Asset Turnover ROI – Ratio: PROFIT PROFIT SALES ROI INVESTMENT SALES INVESTMENT Profit Margin Cheetah Increase in ROI Reduce Reduce Increase Expenses Assets Sales Cheetah ROI in Performance Measurement Advantages – Reflects anything that affects financial statements – Simple to calculate, easy to understand – ROI for competitors is available Disadvantages – Underinvestment into projects with low ROI – Disposal of assets higher ROI but loss in profits – Subjective setting of required rate of return Cheetah EVA EVA – Dollar amount EVA= Net Profit – Capital Charge where Capital Charge = Cost of capital * Capital employed Cheetah Increase in EVA Increase Positive Return Investments Increase Withdraw Negative Efficiency Return Investments Cheetah EVA in Performance Measurement Allows to invest into all projects that generate profit in excess of cost of capital – Example Enables the company to have the same profit objective for comparable investments Uses different rates for different levels of risk Value based performance management Cheetah Division Cheetah Example Suppose of a division earning currently a ROI of 30% and suppose that this division faces an investment opportunity producing a return of 20% with COC of 10% Before After Investment Investment Investment Change Capital 100 20 120 Operating profit 30 4 34 COC 10% 10% 10% ROI 30% 20% 28% -2% EVA 20 2 22 2 Cheetah Example EVA: Accept project ROI Reject project In this case decreasing ROI is good for the shareholders, thus ROI should not be maximized and therefore it is problematic controlling tool Cheetah Cheetah Division Uses ROI: – Ex: Parts ordering size= cost saving- cost of carrying additional inventory Uses purchase price as inventory cost Requires 40% ROI on all investments Cheetah Discussion Topics Team 1: Cheetah Division Team – Why 40% ROI makes sense? – Why 100% purchase value is used? – Why 40% ROI is required for warehouse investment? – What are Cheetah’s suggestions to IMC? Cheetah Discussion Topics Team 2: Operations Research Team – Why 20% makes sense? – Why 60% of the purchase price should be used? – What changes in performance measurement are suggested? – Should Cheetah use the same cost of capital for all kinds of investment? Cheetah Discussion Topics Team 3: Delta Division Group – Why does it accept the 10% of operating cost but not the investment return of 40%? – What is reasonable rate? Why? Cheetah Class Division: Team 1: Amy, Bea, Darnell, Jeff Team 2: George, Jessica, Joyce, Ken Team 3: David, Lisa, Yasuyuki Cheetah Takeaways ROI prevents the company from investing into assets with lower ROI not enough inventory – Solution: different required ROI for inventory Usage of EVA is necessary to evaluate projects with different levels of risk • Example: inventory vs. fixed assets Cheetah Takeaways Different ROI should be used for different investments and divisions • Warehouse problem – Solution: • return on warehouse investment for Delta should reflect “the best alternative”- market rental • Exclusion of the warehouse for Delta from investment base of Cheetah could be a solution Cheetah Thank you for your participation!