Delegation of Decision Making

(Decentralization)
Decision Making
is pushed down.

Top
M anagem ent

M id d le
M anagem ent

S u p e r v is o r

S u p e r v is o r

M id d le
M anagem ent

S u p e r v is o r

S u p e r v is o r

Decentralization often occurs as organizations continue to grow.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Return on Investment (ROI)

Income
ROI =
Invested Capital

Income
Sales Revenue
ROI =

Sales Revenue Invested Capital

Sales
Sales
Margin
Margin
McGraw-Hill/Irwin

Capital
Capital
Turnover
Turnover

The McGraw-Hill Companies, Inc.

Improving R0I
Decrease
Expenses
Increase
Sales
Prices

Lower
Invested
Capital

Three ways to improve ROI

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Residual Income
Investment center profit
Investment charge
= Residual income
Investment capital
Imputed interest rate
= Investment charge
Investment centers
minimum required
rate of return
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Economic Value Added

Investment centers after-tax operating income
Investment charge
= Economic Value Added

(
(

Investment
centers
total assets
After-tax
cost of
debt

McGraw-Hill/Irwin

Investment
centers
current liabilities

) (

Market
value
of debt
Market
value
of debt

Cost of
equity
capital
Market
value
of equity

Weighted
average
cost of capital

Market
value
of equity

The McGraw-Hill Companies, Inc.

Measuring Investment
Center Income
Division managers should be evaluated on
profit margin they control.

Exclude these costs:

Costs traceable to the division but not
controlled by the division manager.
Common costs incurred elsewhere and
allocated to the division.

The key issue is controllability.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Transfer Pricing
The amount charged when one division sells
goods or services to another division

Batteries
Battery Division
McGraw-Hill/Irwin

Auto Division

The McGraw-Hill Companies, Inc.

Transfer Pricing
The transfer price affects the profit measure for
both the selling division and the buying division.
A higher transfer
price for batteries
means . . .

Battery Division
McGraw-Hill/Irwin

greater
profits for the
battery division.

Auto Division

The McGraw-Hill Companies, Inc.

Transfer Pricing
The transfer price affects the profit measure for
both the selling division and the buying division.
A higher transfer
price for batteries
means . . .

Battery Division
McGraw-Hill/Irwin

lower profits
for the
auto division.

Auto Division

The McGraw-Hill Companies, Inc.

General-Transfer-Pricing Rule

Transfer
price

McGraw-Hill/Irwin

Additional outlay
cost per unit
incurred because
goods are
transferred

Opportunity cost
per unit to the
organization
because of
the transfer

The McGraw-Hill Companies, Inc.