24/02/2016

Measuring the

Performance of

Investment Center

Outline

• Return on Investment

• Margin & Turnover

• Advantage of ROI

• Disadvantage of ROI measure

Example

Widya Mandala’s Company

Astrid Division#Net Income = $100,000#Investment = $500,000

Olyvia Division#Net Income = $200,000 #Investment = $2,000,000

Widya Mandala’s Company

Return onInvestment

Is to measure how the company perform

(ROI)

ROI = operating income/average operating assets

Operating income = earning before taxes & interests

Operating assets = are all asset acquired to generate operating

income, cash, receivables, inventories, land, buildings &

equipment

Average operating asset = bg. net book value + ed. net value

2

Example

Widya Mandala’s Company

Astrid Division$100,000/$500,000 = 0.2

Olyvia Division$200,000/$2,000,000 = 0.1

Widya Mandala’s Company

Margin & Turnover

Margin is the ratio of operating income to sales Turn`over it is found by dividing sales by average

operating assets ROI = Margin x Turnover = operating income x sales sales average operating assets

Examples“My” Company earned operating income last year as shown in the following :

Sales $500,000COGS $200,000

-G.Margin $300,000Sell&Adm. Exp $250,000 +OperatingIncome $50,000

AnswerAverage operating system

= (Begining asset + ending asset)/2= (270,000 + 320,000)/2= 295,000

Margin = operating income/sales = 50,000/500,000= 0.10 or 10%

Turnover = Sales/average operating system = 500,000/295,000 = 1.6

Answer

ROI = margin x turnover = 0.10 x 1.6 = 0.16 or 16%

Alternatively, ROI = operating income/average operating asset

= 50,000/295,000 = 0.17

Advantages of ROI

There are at least 3 positive result from the use of ROI :

1. It encourage managers to focus on the relationship among sales, expense & investment

2. It encourage managers to focus on cost efficiency3. It encourage managers to focus on operating asset

efficiency

Disadvantages of ROI

• It can produce narrow focus on divisional profitabilityat the expense of the profitability for the overall firm

• It encourage managers to focus on the short run at the expense of the long run

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