ADVANCED ANALYSIS AND APPRAISAL OF

PERFORMANCE:
FINANCIAL & NONFINANCIAL

Performance Evaluation
- process by which managers at all levels gain

information about the performance of tasks within the

firm and judge that performance against preestablished
criteria as set out in budget, plans, and goals.

FINANCIAL AND NONFINANCIAL PERFORMANCE MEASURES

Financial measures

return on investment
residual income
Internal financial measures based on external financial information

stock price
Internal nonfinancial information
manufacturing lead time
velocity
defect rates
External nonfinancial information
Marketshare
degree of customer satisfaction

STEPS:

1. Choose performance measures that

align with top management's financial
goal.
2. Determine the time horizon of each
performance measure.
3. Define the components of each
performance measure.
4. Choose a measurement alternative
for each performance measure.
5. Decide on a target level of
performance.

Step1.
(a) Return on investment (ROI)
=

Income
investment
or

= Investment turnover

Return on

sales

(b) Residual Income (RI)

= Income - (Required rate of return x
Investment)

 Economic value added (EVA)

After tax operating income
Less: Weigghted Average Cost of Capital x ( Total assets
Current Liabilities)

(d) Return on Sale (ROS)

Operating Income
Sales

Step2.

Reasons:
1. To avoid using single year or short-run changes in

performance measures that could run counter with

the long-run goals of the firm.
2. The benefits of action taken in the current period

may not show up in short-run performance measures.

3. If managers use the net present value method to

make investment decisions, using multi-year RI to

evaluate manager's performances achieve goal
congruence

Step3.
(a) Total

assets available = includes all assets

(b) Total assets employed = total assets minus
the sum of idle assets and assets
purchased for future expansion
(c) Total assets employed
minus current liabilities = excludes
that portion of total assets employed that
are financed by short-term creditors
Shareholder's equity = use of this basis
combines operating decisions made by
managers with financing decisions regarding
equity made by corporate management

Current Cost VS Historical Cost

Current Cost
- amount of cash or cash equivalent that would have to be paid if the

same or an equivalent asset was acquired

- undiscounted amount of cash or cash equivalents that would be

required to settle an obligation currently

Historical Cost
- Assets are recorded at the amount of cash or cash equivalents paid or

the fair value of the consideration given to acquire them at the time of
their acquisition.
- Liabilities are recorded at the amount of proceeds received or in

exchange for the obligation, or in some circumstances at the amounts

of cash or cash equivalents expected to be paid to satisfy the liability in
the normal course of business.

Gross Book Value VS. Net Book Value

Gross book value

- acquisition cost

Net book value

- acquisition cost less accumulated

depreciation

STEP 5:

(1) The careful selection of benchmarks or

targets can help offset shortcomings with
traditional, historical cost-based ROI, RI or EVA
measures.

(2) Many problems of asset valuation and income

measurement can be satisfactorily solved if top
management gets everybody to focus on what is
attainable in the forthcoming budget period.

(3) Another popular way to establis the targets is

to set continuous improvement targets.

STEP 6:

Factors considered in timing the report or

analysis:

(a) how critical is the information for the

success of the organization

(b) the specific level of management that is

receiving the feedback

(c) the sophistication of the organization's

information technology

Illustration.

Consider the following data for the two

geographic divisions of Luzon Electric Company
that operate as profit center:
Northern Luzon Division Southern Luzon
Division
Total Assets
Current Liabilities
Operating Income
750,000

P1M
250 000
200,000

P5M
1.5M

Required:
1. Calculate the ROI for each division using operating
income as the measure of income and using total assets
as the measure of imvesment

Solution
Northern Luzon Division Southern Luzon Division
Total Assets P1M P5M
Operating Income 200,000
750,000
Return on investment
(P200 000/P1M) 20% (P750 000/P5M) 15%

2. Luzon Electric has used RI as a measure of

management performance, what is the RI for
each division using operating income and total
assets if the required rate of return on investment
is 12%?
NorthernSouthern
Residual income @
12% required rate of return
P80,000
P150,000
Northern: P200 000 (0.12 x P1M) = P80 000
Southern: P750 000 (0.12 x P5M) = P150 000

3. Luzon Electric has two sources of funds: long-term

debt with a market value of P3,500,000 and an
interest rate of 10%, and equity capital with a market
value of P3,500,000 at a cost of equity of 14%.
Luzon's income tax rate is40%. Luzon applies the
same weighted-average cost of capital to both
divisions, since each division faces similar risks.
Calculate the EVA for each division.
After-tax cost of debt = 6%
After-tax cost of equity financing = 14%
The weighted average cost of capital (WACC)
= (6% x P3.5M) + (14% x P3.5M)
P3.5M + P3.5M
= P210 000 + P490 000
P7M
= 0.10 or 10%

ECONOMIC VALUE ADDED (EVA)

Northern

Southern

After tax Operating Income

Northern (200 000 x 0.6)

120 000

Southern (750 000 x 0.6)

Less: Cost of Capital
Northern [(10% x (1M 250 000)]
Southern [(10% x (5M 1.5M)]

450 000
75 000
350 000

45 000 100 000

4. Calculate the ROS for each division.

Northern = 200 000

5M
= 4%
Southern = 750 000

15M
= 4%

Performance Measurement in Multinational

Companies
Computation of Foreign Division's ROI in the Foreign
Currency
Supposed DGC Phils. invests in a hotel in Guam on
December 31, 2014. The invesment consists
mainly of the costs of buildimgs and furnishing.
The following data are also assumed:
Exchange rate on Dec. 31, 2014 $1 = P55
Exchange rate on Dec. 31, 2015 $1 = P56
Average exchange rate during 2015
[(P55 + P56) / 2)] $1 = P55.50
Investment (total assets) in Guam P55M
Operating income of the Guam Hotel in 2015 P10M

What is the historical cost-based ROI for

the Guam in 2014?
ROI = P10M
P55M
= 0.1818 or 18.2%

What is the ROI calculated using dollars?

ROI = P10M / P55.50

P55M / P55
= $180 180
$1M
= 18.02%

The End
Thank You

Reporter:
Christiana Jade P. de
Guzman
Leizel Jane L. Caldeo