问答题
3.Beach Foods (Beach) is a family-owned business which has grown strongly over its 100 year history. The objective of the business is to maximise the family’s wealth through their shareholdings. Beach has three divisions. It manufactures a variety of foods in two of the divisions: Beach Baby Foods (Baby) and Beach Chocolate Foods (Chocolate). Each of these divisions knows its own market and sets prices accordingly. The third division (R&D)researches new products on the instructions of the other divisions and is considered to be vital to the survival and growth of Beach. The board of Beach has been considering the impact of using a divisional structure and has come to you as a performance management consultant to ask for your advice.
There is disagreement at board level about the correct choice of divisional performance measure to be used in the two manufacturing divisions. Currently, the business uses EVATM but two directors have been questioning its value,complaining that it is complicated to understand. These directors have been promoting the use of either residual income (RI) or return on investment (ROI) as alternatives. The board wants to use the same measure for each division.As well as qualitatively evaluating these different measures, the board needs an assessment of the impact of a change in performance measure on their perception of these divisions’ performance. Therefore, as an example, they require you to calculate and discuss the use of ROI and RI at Baby division, given the data in Appendix 1.
The chief executive officer (CEO) of Beach has engaged a business analyst to perform a study of the portfolio of manufacturing businesses which make up Beach. This has been completed in Appendix 2. The CEO wants your comments (based on the categorisation given in Appendix 2) on how this work will impact on the performance management of the divisions. Specifically, the CEO has asked for your recommendations on how to control each division; that is, whether each division should be treated as a cost/profit/investment centre and also, the appropriate management style to use for handling staff in each division. The CEO commented to you:
‘I have heard of different approaches to the use of budget information in assessing performance: budget-constrained,profit-conscious and also a non-accounting style. I need to know how these approaches might apply to each division given your other comments.’
All of this work has been partly prompted by complaints from the divisional managers. The Chocolate divisional managers complain that they had to wait for a year to get approval to upgrade their main production line. This production line upgrade has reduced wastage and boosted Chocolate’s profit margin by 10 percentage points. The Baby division has been very successful in using the ideas of the R&D division, although Baby’s managers do complain about the recharging of R&D costs to their division. Head office managers are worried about Chocolate as it has seemed to be drifting recently with a lack of strategic direction. Chocolate’s managers are considered to be good but possibly not sufficiently focused on what benefits Beach as a whole.
问答题
(a) Assess the use of EVA TM as a divisional performance measure for the manufacturing divisions at Beach.(8 marks)
【正确答案】Economic value added (EVATM) as a divisional performance measure
The main benefit to EVATM is its link to the overall corporate objective of adding shareholder value. It is an appropriate measure to use if the company is applying value-based management. Therefore, by using it as a divisional performance measure, divisional managers should also be motivated to work in the best interest of the company as a whole and this ought to be one of the main objectives of a divisional performance measure.
The other advantages of EVATM are that:
– It gives an absolute measure so showing the overall contribution to the company.
– The basic test of performance is simple since if EVATM is positive, then the division is generating a return above that required by the providers of finance. (ROI requires a target level to be set usually based on benchmarking to the industry sector.)
– The adjustments within the calculation of EVATM mean that the measure is closer to cash flows than accounting profits and so is less subject to choices in accounting policies.
– EVATM encourages investment for the future (for example, in advertising and development) by removing such costs from the performance period and treating them like capital expenditure. This will reduce the dysfunctional temptation for management to engage in some short-term decision-making, which can be a problem with the capital employed figure from the financial statements which is used in ROI and RI. This is likely to be particularly appropriate at Beach, where R&D is significant.
However, EVATM does have disadvantages, some of which are common to the two suggested alternative measures and some which are specific.
All three measures are dependent on historical data and so are only of limited use in forecasting future performance.
The specific criticism of EVATM that it is complicated is reasonable as the full version requires more than 100 adjustments to the information in the normal financial statements. RI and ROI are derived from headline information in the financial statements which would be more familiar to the board.
EVATM (like RI) uses a charge for the capital employed in the division. EVATM uses the weighted-average cost of capital for the company as a whole and may not reflect the risks of the division. However, RI uses a notional cost of capital based on the risk of the division, which will be subject to an element of judgement and estimate. Also, as an unlisted business, the estimation of WACC is difficult.
Unlike ROI, EVATM would not help to judge relative divisional managerial performance at Beach if the divisions are not of similar size.
It is sensible to avoid consideration of the R&D division in this discussion as it is not a revenue-generating division.
【答案解析】
问答题
(b) Using Appendix 1, calculate the ROI and RI for Baby and assess the impact of the assumptions made when calculating these metrics on the evaluation of the performance of this division and its management.(7 marks)
【正确答案】
【答案解析】
问答题
(c) Provide justified recommendations for each division’s control and management style as requested by the CEO. (10 marks)
【正确答案】Baby division
As the star of the Beach portfolio and with new products launching, it would appear sensible that Baby was an investment division with the autonomy to continue to develop its business successfully. However, it is unclear where the decision to commit to a new product rests as the R&D division actually does the development work. In that case, it may be appropriate to make Baby a profit centre and manage it according to its profit generating ability. The business is rapidly growing and so a budget-constrained style would be inappropriate as it would stifle the creativity necessary for such a division. Alternatively,a non-accounting style where criteria other than profit such as revenue growth and new product development may be appropriate. Once the market sector has matured further then given a strong market share, the focus of the division will move to optimising profit.
Chocolate division
As the cash cow of the Beach portfolio, Chocolate should be run for the profit which it generates. It could be classified as a profit centre since its sector is mature and there are unlikely to be plans to make new investment. Alternatively, it could be classified as an investment centre so it does not have to wait for approval of limited capital expenditure such as happened with the production line upgrade. The management style should be budget-constrained with special emphasis placed on the ability of the division to generate cash not just profit.
R&D division
The R&D division has no source of revenue other than internal recharge of its services and so it should be a cost centre.However, the value of the division will only be appreciated if the overall profit generated from these new products can be demonstrated. This may be the cause of the problem with the Baby division managers. They only see the recharge cost appearing in their performance reports without the revenue which these new products are generating being specifically disclosed. It may be helpful to have a profit calculated for each product over its lifecycle to demonstrate the value of the division which is seen by Beach as vital.
A budget-constrained style of management would be appropriate where the budget is set separately for each new product development project. However, it would be important not to constrain the division within a fixed overall budget if there is a number of good product development ideas. The generation of ideas may be helped by using a non-accounting style, giving priority to more than just budget numbers (e.g. number of new product ideas/favourable press comments on new product launches).
A specific approach will therefore need to take account of all these factors in order to arrive at a style of management which meets the needs of the company as a whole.
【答案解析】