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    PM 07 Divisional Performance Measures Notes

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    There are two key measures used to assess divisional performance: return on investment (ROI) and residual income (RI). Three characteristics are desirable: goal congruence, autonomy, and fair performance assessment. ROI can result in non-goal congruent behavior, while RI achieves goal congruence but is more difficult to compare divisions. Other factors like manager experience and market conditions also impact divisional performance.

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    PM 07 Divisional Performance Measures Notes

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    Tanya
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    There are two key measures used to assess divisional performance: return on investment (ROI) and residual income (RI). Three characteristics are desirable: goal congruence, autonomy, and fair performance assessment. ROI can result in non-goal congruent behavior, while RI achieves goal congruence but is more difficult to compare divisions. Other factors like manager experience and market conditions also impact divisional performance.

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    There are two key measures used to assess divisional performance: return on investment (ROI) and residual income (RI). Three characteristics are desirable: goal congruence, autonomy, and fair performance assessment. ROI can result in non-goal congruent behavior, while RI achieves goal congruence but is more difficult to compare divisions. Other factors like manager experience and market conditions also impact divisional performance.

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    12 views2 pages

    PM 07 Divisional Performance Measures Notes

    Uploaded by

    Tanya
    There are two key measures used to assess divisional performance: return on investment (ROI) and residual income (RI). Three characteristics are desirable: goal congruence, autonomy, and fair performance assessment. ROI can result in non-goal congruent behavior, while RI achieves goal congruence but is more difficult to compare divisions. Other factors like manager experience and market conditions also impact divisional performance.

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    PM - Performance Measurement & Control

    Divisional Performance Measures

    KEY MEASURES AND CHARACTERISTICS:

    There are two key measures which are used to assess the performance of a company division:

    1) Return on investment (ROI);


    2) Residual income (RI).

    The following characteristics are desirable when looking to successfully appraise a division’s performance:

    1) Goal Congruence. Divisional managers should make decisions that are in the best interests of the division
    and the company (or group) as a whole;
    2) Autonomy. The divisional manager should be able to act and make decisions independently of the
    company head office;
    3) Performance assessment. Goal congruence and divisional autonomy should mean the evaluation of the
    division’s performance is possible and fair.

    Note: A conflict between goal congruence and autonomy can often arise if managers are allowed too much
    autonomy and they may make decisions that are not in the best interests of the company as a whole. However if
    autonomy is withdrawn, this can make it difficult to accurately assess performance.

    RETURN ON INVESTMENT (ROI):

    Return on investment is calculated as follows:

    Net profit
    Return on investment (ROI) =
    Investment cost
    Note: Using ROI will encourage divisional managers to make decisions that are in their best interests but not
    necessarily the best interests of the company as a whole, which is referred to as dysfunctional behaviour or
    non-goal congruent behaviour.

    RESIDUAL INCOME (RI):

    Residual income is calculated as follows:

    Residual income (RI) = Profit - Imputed interest

    Imputed interest = Investment * Cost of capital

    Note: If the residual income is positive, the investment is acceptable to the division.

    DIFFERENCES BETWEEN ROI AND RI:

    RI ROI

    - Could be viewed as the superior method - Can result in dysfunctional behaviour


    of investment appraisal as goal meaning company profits are not
    congruence should be achieved; maximised thus hampering fair
    evaluation of division’s performance;
    - It is expressed as an absolute measure
    which makes it more difficult to compare - It is a relative measure expressed as a
    divisional performance; percentage, which facilitates inter-
    divisional comparisons and makes it
    - Estimation of a cost of capital is required easier to understand;
    for the RI calculation.
    - No cost of capital estimation is required
    when calculating ROI.

    Other factors to be considered when evaluating or comparing divisional performance:

    - How experienced is the divisional manager?


    - How buoyant is the market for each division’s goods and services?
    - What is the age profile of the assets within each division?

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