© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Decision Making is pushed down. Delegation of Decision Making (Decentralization) Decentralization often occurs as organizations continue to grow.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Return on Investment (ROI) ROI = Income Invested Capital ROI = Income Sales Revenue × Invested Capital Sales Margin Sales Margin Capital Turnover

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Improving R0I Three ways to improve ROI Ê Increase Sales Prices Sales Prices Ë Decrease Expenses Expenses Ì Lower Invested Capital Invested Capital

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Residual Income Investment center profit – Investment charge = Residual income Investment capital × Imputed interest rate = Investment charge Investment center’s minimum required rate of return

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Economic Value Added Investment center’s after-tax operating income – Investment charge = Economic Value Added Weighted average cost of capital  Investment center’s total assets Investment center’s current liabilities – () After-tax cost of debt Market value of debt Cost of equity capital Market value of equity  (() ) Market value of debt Market value of equity  

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Measuring Investment Center Income Division managers should be evaluated on profit margin they control. Division managers should be evaluated on profit margin they control. l Exclude these costs: l Costs traceable to the division but not controlled by the division manager. l Common costs incurred elsewhere and allocated to the division. The key issue is controllability.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Transfer Pricing The amount charged when one division sells goods or services to another division Battery DivisionAuto Division Batteries

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The transfer price affects the profit measure for both the selling division and the buying division. The transfer price affects the profit measure for both the selling division and the buying division. A higher transfer price for batteries means... greater profits for the battery division. Auto DivisionBattery Division Transfer Pricing

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin lower profits for the auto division. The transfer price affects the profit measure for both the selling division and the buying division. The transfer price affects the profit measure for both the selling division and the buying division. Auto DivisionBattery Division Transfer Pricing A higher transfer price for batteries means...

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin General-Transfer-Pricing Rule Transfer price Additional outlay cost per unit incurred because goods are transferred Opportunity cost per unit to the organization because of the transfer = +