Decentralization and ROI Analysis

Final Study material: may need to add what equations tell us

ROI normal equation

NOI/Average Operating Assets

How can you find ROI w/margin and turnover?

Margin \* Turnover

Margin formula

NOI/Sales

Turnover Formula

Sales/Average Operating Assets

How can you set transfer pricing the three ways?

* Negotiated: transfer prices (segment managers meet to discuss and agree upon transfer prices) 
* Full: Setting transfer prices at cost using either variable cost/full absorption cost 
* Market: Use market price  

Sellers Perspective of Negotiated Transfer Prices

TP > = VC per unit + (total CM on lost sales/ # units transferred)

Residual Income equation

RI = NOI - (Avg operating assets \* minimum req rate of return)  

How to find contribution margin?

Revenues - variable costs

Decentralization

Co. Divides/transfer/spread decision making power to other authorities/people instead of being confined to a few top executives  

Disadvantages of Decentralization

* Decrease coordination among segments 
* Lower level mgmt may make decisions w/o seeing big picture  
* Goal congruence problems and loyalty problems 
* Decisions may be set up to reward yet that reward might not be = big picture 
* Inability to spread innovative ideas  

Advantages of Decentralization

* Pools of people feel that their contribution matters and it does
* Freedom of Sr mgmt to concentrate on strategic functions 
* Decision making power is using better info
* More timely  
* More training opportunities for lower mgmt 

Cost Center def and example

Segment that controls costs (doesn't have product or service associated with it) 

* Ex: an IT department it helps other dept. doesn't sell service outside 

Profit Centers

have some sort of product (geographic regions might have these) they are responsible for generating revs and controlling cost 

Investment Center

Is going to generate rev control costs and make asset purchasing decisions  

How do you evaluate cost centers?

Evaluate via variances from cost budgets 

How do you evaluate profit centers?

Evaluate via segment margin or variances from cost budgets and rev budgets 

How do you evaluate investment centers?

Evaluate via ROI aka Return on Assets and Residual Income or Segment margin or variances from cost and revenue budgets  

Segment Margin

Rev - variable costs = CM - traceable costs = segment margin

Relationship btw RI and ROI

If ROI is larger than minimum required rate of return RI is positive.

Interpretation of ROI

Profit earned per dollar invested

Interpretation of Margin

for every dollar in sales there are ___ cents (relating to the percentage) as operating income. The remaining cents is operating expenses.

Interpretation of Residual Income

NOI remaining after subtracting min req rate of return on operating assets.