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    Ch7 Measuring and Controlling Assets Employed

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    Keren Millet
    This document contains financial information for a business unit, including its balance sheet, income statement, capital investments, and effects of depreciation methods. It shows how return on investment (ROI) and economic value added (EVA) can differ as performance measures. ROI only looks at profitability while EVA considers the capital charge for funds invested. Smoothing depreciation over the life of an asset results in a more stable EVA over time compared to straight-line depreciation. Leasing assets can improve EVA by reducing the capital charge compared to purchasing the assets. The document demonstrates that EVA, unlike ROI, can identify the business unit that is truly adding economic profit after considering the cost of capital employed.

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    Ch7 Measuring and Controlling Assets Employed

    Uploaded by

    Keren Millet
    270 views5 pages
    This document contains financial information for a business unit, including its balance sheet, income statement, capital investments, and effects of depreciation methods. It shows how return on investment (ROI) and economic value added (EVA) can differ as performance measures. ROI only looks at profitability while EVA considers the capital charge for funds invested. Smoothing depreciation over the life of an asset results in a more stable EVA over time compared to straight-line depreciation. Leasing assets can improve EVA by reducing the capital charge compared to purchasing the assets. The document demonstrates that EVA, unlike ROI, can identify the business unit that is truly adding economic profit after considering the cost of capital employed.

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    This document contains financial information for a business unit, including its balance sheet, income statement, capital investments, and effects of depreciation methods. It shows how return on investment (ROI) and economic value added (EVA) can differ as performance measures. ROI only looks at profitability while EVA considers the capital charge for funds invested. Smoothing depreciation over the life of an asset results in a more stable EVA over time compared to straight-line depreciation. Leasing assets can improve EVA by reducing the capital charge compared to purchasing the assets. The document demonstrates that EVA, unlike ROI, can identify the business unit that is truly adding economic profit after considering the cost of capital employed.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    270 views5 pages

    Ch7 Measuring and Controlling Assets Employed

    Uploaded by

    Keren Millet
    This document contains financial information for a business unit, including its balance sheet, income statement, capital investments, and effects of depreciation methods. It shows how return on investment (ROI) and economic value added (EVA) can differ as performance measures. ROI only looks at profitability while EVA considers the capital charge for funds invested. Smoothing depreciation over the life of an asset results in a more stable EVA over time compared to straight-line depreciation. Leasing assets can improve EVA by reducing the capital charge compared to purchasing the assets. The document demonstrates that EVA, unlike ROI, can identify the business unit that is truly adding economic profit after considering the cost of capital employed.

    Copyright:

    Attribution Non-Commercial (BY-NC)
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    of 5

    7.

    1 Business Unit Financial Statements


    Balance Sheet
    ($000s)
    Current Assets
    Cash
    50
    Receivables
    150
    Inventory
    200
    Total Current Assets
    400
    Fixed Assets
    Cost
    600
    Less : Depreciation
    -300
    Book value
    300
    Total Assets
    700
    Revenues
    Expenses except Depreciation
    850
    Depreciation
    50
    Total Expenses
    Income before taxes
    Capital charge (500 @10% )
    Economic Value Added
    Return on Investment : 100/500 = 20%

    Current Liabilities
    Accounts payable
    Other current liabilities
    Total Current Liabilities
    Corporate Equity

    90
    110
    200
    500

    Total Equities

    700
    1000
    900
    100
    50
    50

    7.3 Incorrect Motivation for Asset Acquisition


    ($000s)
    A. Economic Calculation
    Investment in machine
    100
    Life 5 years
    Cash inflow $27,000 per
    year
    Present Value of cash flow
    102.4
    ($27,000 x 3.791 )
    Net Present value
    2.4
    Decision : To acquire the machine
    B. As reflected on business units Income Statement
    As in 7.1
    Revenue
    Expenses except
    Depreciation
    850
    Depreciation
    50
    Total
    Income before taxes
    Less : Capital charge
    @10%
    EVA

    1000

    First year
    with Machine
    1000

    823
    70
    900
    100
    50

    893
    107
    60

    50

    47

    7.4 Effect of Acquisition on Reported Annual Profits ($000s )


    Year Book Value Incremental
    Capital
    EVA
    At Begin of
    Income *
    Charge +
    year
    a
    b
    c
    b-c
    1
    100
    7
    10
    -3
    2
    80
    7
    8
    -1
    3
    60
    7
    6
    1
    4
    40
    7
    4
    3
    5
    20
    7
    2
    5
    Note : True return = approximately 11 per cent
    * $27,000 cash inflow - $20,000 Depreciation = $7000 .
    + 10 per cent of beginning book value

    ROI
    b/a
    7%
    9
    12
    18
    35

    7.5 Profitability Using Annuity Depreciation Smoothing EVA ( $000)


    Year
    Beginning
    Cash
    EVA*
    Capital
    Depreciation
    Book value Inflow
    Charge +
    #
    1
    $100
    $27.0
    $0.6
    $10.0
    $16.4
    2
    83.6
    27.0
    0.6
    8.4
    18.0
    3
    65.6
    27.0
    0.6
    6.6
    19.8
    4
    45.8
    27.0
    0.6
    4.6
    21.8
    5
    24.0
    27.0
    0.6
    2.4
    24.0
    Total
    $135
    $3.0
    $32.0
    100.0
    7.6 Profitability Using Annuity Depreciation Smoothing ROI ( $000)
    Year
    Beginning
    Cash
    Net Profit* Depreciation Return on
    Book value Inflow
    +
    Beginning
    Investment
    1
    2
    3
    4
    5
    Total

    $100
    83.6
    65.6
    45.8
    24.0

    $27.0
    27.0
    27.0
    27.0
    27.0
    $135

    11.0
    9.2
    7.3
    5.1
    2.4
    35.0

    16.0
    17.8
    19.7
    21.9
    24.6
    100.0

    Valuation of Plant and Equipment

    Gross book value


    Net book value
    Replacement cost

    Percentage of Respondents using this method


    USA
    Holland
    India
    6%
    9%
    17%
    93
    73
    79
    1
    18
    4
    100
    100
    100

    11%
    11
    11
    11
    10
    10 %

    7.8 Effect of Leasing Assets

    Revenue
    Expenses other
    than below :
    $850
    Depreciation
    50

    Income Statement ($000)


    As in Exhibit 3
    $1000
    $850

    Rental expense Income before


    taxes
    Capital charge
    EVA

    60
    900
    100

    $500x10%
    $200x10%

    If assets are leased


    $1000

    910
    90

    50
    50

    20
    70

    EXHIBIT 7.12 :
    Difference between ROI and EVA
    Business Unit

    Cash

    Receivable

    Inventories

    Fixed Assets

    Total
    investment

    Budgeted
    Profit

    A
    B
    C
    D
    E

    $10
    20
    15
    5
    10

    $ 20
    20
    40
    10
    5

    $30
    30
    40
    20
    10

    $ 60
    50
    10
    40
    10

    $120
    120
    105
    75
    35

    $24.0
    14.4
    10.5
    3.8
    (1.8)

    Business
    Unit
    A
    B
    C
    D
    E

    (1)
    Profit
    Potential
    24.0
    14.4
    10.5
    3.8
    (1.8)

    Current Assets
    (2)
    (3)
    Amount
    Rate
    $60
    79
    95
    35
    25

    4%
    4
    4
    4
    4

    (4)
    Required
    Earnings
    $2.4
    2.8
    3.8
    1.4
    1.0

    (5)
    Amount
    $60
    50
    10
    40
    10

    Fixed Assets
    (6)
    (7)
    Rate
    Required
    Earnings
    10%
    $6.0
    10
    5.0
    10
    1.0
    10
    4.0
    10
    1.0

    ROI
    Objective
    (6) / (5)
    20%
    12
    10
    5
    (5)

    Budgeted
    EVA
    $15.6
    6.6
    5.7
    (1.6)
    (3.8)

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