McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Rewarding Business Rewarding Business PerformancePerformance

Chapter 25

Goal CongruenceAlignment of employee goals

and objectives with organizational goals and

objectives.

Motivation and AligningMotivation and AligningGoals and ObjectivesGoals and Objectives

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Motivation and AligningMotivation and AligningGoals and ObjectivesGoals and Objectives

Feedback Steer employees toward goals Measure progress in achieving goals

Measureperformance

Improveperformance

Rewardperformance.

Rewardperformance

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Return on Investment (ROI)Return on Investment (ROI)

Return on investment is the ratio ofoperating income to the average

investment used to generate the income.

Return on investment is the ratio ofoperating income to the average

investment used to generate the income.

ROI = Operating Income Average Total Assets

Using ROI to evaluate business performanceis often referred to as the DuPont system.

Using ROI to evaluate business performanceis often referred to as the DuPont system.

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SalesAverage Total Assets

ROI = Operating Income

Average Total Assets

ROI = Operating Income

Sales ×

Return on Investment (ROI)Return on Investment (ROI)

Returnon SalesReturn

on SalesCapital

TurnoverCapital

Turnover

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Improving ROIImproving ROI

Increase Sales Prices

Decrease Expenses

Lower Invested Capital

Three ways to improve ROI

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Criticisms of ROICriticisms of ROIAs division manager at Winston, Inc., your

compensation package includes a salary plus bonus based on your division’s ROI -- the higher your ROI, the bigger your bonus.

The company requires an ROI of 15% on all new investments -- your division has been producing an ROI of 30%.

You have an opportunity to invest in a new project that will produce an ROI of 25%.

As division manager would you invest in this project?

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As division manager,I wouldn’t invest in

that project becauseit would lower my pay!

Failure to Undertake Failure to Undertake Profitable InvestmentsProfitable Investments

Gee . . .I thought we were

supposed to do what was best for the

company!

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Operating Earnings– Investment charge = Residual income

Investment capital× Minimum return = Investment charge

Residual Income and Residual Income and Economic Value AddedEconomic Value Added

Investment center’sminimum acceptable

return

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Residual income encourages managers to make profitable investments that would

be rejected by managers using ROI.

Residual IncomeResidual Income

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Economic Value AddedEconomic Value Added

Economic value added is the annual after-tax operating profit minus the total annual

cost of capital.

Cost of capital is weighted-average after-taxcost of long-term borrowing and the cost

of equity.

DebtEquity

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After-tax Operating Income– Investment charge = Economic value added

(Total assets – current liabilities)× Weighted-average cost of capital= Investment charge

After-tax cost oflong-term borrowing

and the cost of equity

Economic Value AddedEconomic Value Added

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Economic Value AddedEconomic Value Added

Economic value added can be improved in three ways . . .

Increase profit without using more capital.

Use less capital to earn the same amount of profit.

Invest capital in high-return projects.

Economic value added can be improved in three ways . . .

Increase profit without using more capital.

Use less capital to earn the same amount of profit.

Invest capital in high-return projects.

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Financial PerspectiveHow do we look

to the firm’s owners?

Learning and Growth Perspective

How can we continuallyimprove and create value?

Business ProcessPerspective

In which activities must we excel?

Customer PerspectiveHow do our

customers see us?

Balanced ScorecardBalanced Scorecard

Visionand

Strategy

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Difficulties with the Difficulties with the Balanced ScorecardBalanced ScorecardSome of the difficulties noted by companies using the balance scorecard include:1.Organizations have difficulty assessing the importance or weights attached to the various perspectives that are part of the scorecard.2.Measuring, quantifying, and evaluating some of the qualitative components that are part of the balanced scorecard present significant technical hurdles.3.Difficulty arises from a lack of clarity and sense of direction because of the large number of performance measures.4.The time and expense required to maintain and operate a fully designed system can be significant.

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End of Chapter 25End of Chapter 25

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