Difference Between Eva And Roi 1a6u5k

Q.3 (a) Difference between EVA and ROI. Most of the companies employing investment centers evaluate business units on the basis of Return on Investment (ROI) rather than Economic Value Added (EVA). There are three apparent benefits of an ROI measure. 1. First, it is, a comprehensive measure in that anything that affects financial statements is reflected in this ratio. 2. Second, Return on Investment (ROI) is simple to calculate, easy to understand, and meaningful in an absolute sense. For example, an ROI of less than 5 percent is considered low on an absolute scale, and an ROI of over 25 percent is considered high. 3. Finally, it is a common denominator that may be applied to any organizational unit responsible for profitability, regardless of size or type of business. The performance of different units may be compared directly to one another. Also, ROI data are available for competitors and can be used as a basis for comparison. The collar amount of Economic Value Added (EVA) does not provide such a basis for comparison. Nevertheless the EVA approach has some inherent advantages. There are four competing reasons to use EVA over ROI: 1. First, with EVA all business units have the same profit objective for comparable investments. The ROI approach, on the other hand, provide, different incentive; for investments across business units. For example, a business unit that currently is achieving an ROI of 30 percent would be reluctant to expand unless it is able to earn on ROI of 30 percent or more on additional assets: a lesser return would decrease its overall ROI below its current 30 percent level. Thus, this business unit might forgo investment an opportunity that’s ROI is above the cost of capital but below 30 percent. 2. The use of ROI as a measure deals with both these problems. They relate to asset investment whose ROI falls between the cost of capital and the center’s current ROI. If investment center’s performance is measured by EVA, investments that practice a profit in excess of the cost of capital will increase EVA and therefore economically attractive to the manager. 3. A third advantage of EVA is that different interest rates may be used for different types of assets. For example, a low rate may be used for inventories while a relatively higher rate may be used for investments in fixed assets. Furthermore, different rates may be used for different types of fixed assets to take into different degrees of risk. In short, management control systems can be made considered with the framework used for decisions about capital investments and resources allocation. It follows that the same type of asset may be required to earn the same return throughout the company, regardless of the particular business nits profitability. Thus, business unit managers should act consistently when a deciding to invest in new assets. 4. A fourth advantage is that EVA, in contrast to ROI, has a stronger positive correction with changes in a company’s market value. There are several reasons why shareholder value creation is critical for the firm: It (a) reduces the risk of takeover, (b) creates

currency for aggressiveness in mergers and acquisitions, and (c) reduces cost of capital, which allows faster investment for future growth, Thus, optimizing shareholder value is an important goal of an enterprise. However, since shareholder value measures the worth of the consolidated enterprise as whole n is nearly impossible to use it as a performance criterion for an organization individual responsibility centers. The best proxy for shareholder value at the business unit level is to ask business unit managers to create and grow EVA. It indicates that companies with high EVA tend to show high market value added (MVA) or high gains for shareholders. When used as a performance metric, EVA motivates managers to increase EVA by taking actions consistent with increasing stockholder value.

Q.3 (b) Discuss in detail various elements of management control system and draw diagram depicting various elements of management control process. Management control systems (MCS) is a system which gathers and uses information to evaluate the performance of different organizational resources like human, physical, financial and also the organization as a whole considering the organizational strategies. MCS influences the behavior of organizational resources to implement organizational strategies. Management control systems are tools to aid management for steering an organization toward its strategic objectives. Management controls are only one of the tools which managers use in implementing desired strategies. However strategies get implemented through management controls, organizational structure, human resources management and culture It is like a black box whose exact nature cannot be observed. MCS involves the behavior of managers and these behaviors cannot be expressed by equations. According to Horngren et al. (2005), management control system is an integrated technique for collecting and using information to motivate employee behavior and to evaluate performance. According to Simons (1995), Management Control Systems are the formal, information-based routines and procedures managers use to maintain or alter patterns in organizational activities According to Maciariello et al. (1994), management control is concerned with coordination, resource allocation, motivation, and performance measurement Elements of management control system: 1. 2. 3. 4. 5. 6. 7.

Strategic Planning, Budgeting, Resource Allocation, Performance Measurement, Evaluation And Rewards, Responsibility Center Allocation And Transfer Pricing

Q.4 Define Profit Center. Discuss the types of profitability measures. A profit center is a branch or division of a company that is ed for on a standalone basis for the purposes of profit calculation. A profit center is responsible for generating its own results and earnings, and as such, its managers generally have decisionmaking authority related to product pricing and operating expenses. Profit centers are crucial in determining which units are the most and least profitable within an organization. A profitability ratio is a measure of profitability, which is a way to measure a company's performance. Profitability is simply the capacity to make a profit, and a profit is what is left over from income earned after you have deducted all costs and expenses related to earning the income. The formulas you are about to learn can be used to judge a company's performance and to compare its performance against other similarly-situated companies. Profitability Ratios Common profitability ratios used in analyzing a company's performance include gross profit margin (GPM), operating margin (OM), return on assets (ROA) , return on equity (ROE). 

Gross margin tells you about the profitability of your goods and services. It tells you how much it costs you to produce the product. It is calculated by dividing your gross profit (GP) by your net sales (NS) and multiplying the quotient by 100: o Gross Margin = Gross Profit/Net Sales * 100 o GM = GP / NS * 100

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Operating margin takes into the costs of producing the product or services that are unrelated to the direct production of the product or services, such as overhead and istrative expenses. It is calculated by dividing your operating profit (OP) by your net sales (NS) and multiplying the quotient by 100: o Operating Margin = Operating Profit / Net Sales * 100 o OM = OP / NS * 100

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Return on Assets measures how effectively the company produces income from its assets. You calculate it by dividing net income (NI) for the current year by the value of all the company's assets (A) and multiplying the quotient by 100: o Return on Assets = Net Income / Assets * 100 o ROA = NI/A * 100

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Return on equity measures how much a company makes for each dollar that investors put into it. You calculate it by taking the net income earned (NI) by the amount of money invested by shareholders (SI) and multiplying the quotient by 100: o Return on Equity = Net Income / Shareholder Investment * 100 o ROE = NI / SI * 100

Q.5 What is Cost Center? Distinguish Engineered and Discretionary Cost Center. Cost Centre A cost centre is a responsibility centre in which manager is held responsible for controlling cost inputs. There are two general types of cost centres: engineered expense centres and discretionary expense centres. Engineered costs are usually expressed as standard costs. A discretionary expense centre is a responsibility centre whose budgetary performance is based on achieving its goals by operating within predetermined expense constraints set through managerial judgement or discretion. Discretionary Expense Centre Discretionary costs are those for which no such engineered estimate is feasible; the amount of costs incurred depends on management's judgment about the amount that is appropriate under the circumstances. The costs of the inputs, or resources required to perform such activities are referred to as discretionary costs. It is also called Discretionary Expenditure or Managed Cost Discretionary costs relate to company activities that are important but whose level of funding is subject to judgment. Discretionary costs are generated by activities that vary in type and magnitude from day-today and whose benefits are often not measurable in monetary . In addition, performance quality can also vary according to the task and employee skill levels involved. Engineered Expense Centre Engineered costs are elements of cost for which the "right" or "proper" amount of costs that should be incurred can be estimated with a reasonable degree of reliability. For example : Costs incurred in a factory for direct labor, direct material, components, supplies, and utilities. Characteristics •

Their input can be measure in monetary .

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Their output can be measured in physical

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The optimal rupee amount of input required to produce one unit of output can be established.