Unit One: Case Study (MIP)
Kaplan University – GB519 Measurement and Decision Making
What is the ROI for MIP based on original estimates?
• Operating assets ( development costs were $140 million
• Sales ( annual operating income was expected to be approximately $25 million
ROI for MIP = 25 million / 140 million = .18%
What is the ROI if Richard Lawrence’s new revenue projects are used?
• likely generate operating income of just $17.5 million per year
ROI for MIP with new figures = 17.5 million / 140 million = .13%
Elaine feels pressure to deliver “good news” to Blake. What advice would you give to her? Given the possible ...view middle of the document...
The use of ROI has some drawbacks. Because it uses the net book value on the cost of the assets it can be deceiving because as time goes by the asset is in actuality depreciated with less value. These values are not utilized in simple ROI. Using the net book value causes ROI to get bigger over time because of the reduction in book value of assets used in the calculations (Jackson, Sawyers, Sweeney, & Adnderson, 2008).
Residual income is the amount of income earned over and above of a predetermined minimum rate of return on those assets (Jackson, Sawyers, Sweeney, & Adnderson, 2008). With everything being equal, the better the residual income is of an investment center the more positive result (Jackson, Sawyers, Sweeney, & Adnderson, 2008). However, that is the drawback with residual income; all things are not usually equal.
The best way to determine value is the economic value added (EVA) percentage. “EVA is based on after tax operating profit rather than before tax operating profit. In the EVA calculation, assets are often shown net of current liabilities. Reducing assets by current liabilities focuses attention on assets financed from long-term sources of capital rather than short-term borrowing that will require repayment in the near future. The weighted average cost of capital considers the cost of both debt and equity financing as compared to a minimum required rate of return that is frequently used in residual income calculations” (Jackson, Sawyers, Sweeney, & Adnderson, 2008).
ROI was the best way to calculate the values in the MIP case study as there was limited quantitative data given in the story. We could not calculate EVA as there was no financing information given. Along with EVA, residual income could not be calculated because the year sales figures were not equal. There was also not a predetermined minimum rate of return given to us.
Jackson, S., Sawyers, R., Sweeney, D., & Adnderson, D. (2008). Managerial Accounting and Statistics. Mason: Cengage Learning.
Chapter 1: Case 53
Elaine Shumate has been working for GSM, a pharmaceutical research company, for more than seven years. It is...