topic 2 : SBUs

Question 1

state the three accounting measures of strategy success.

Answer 1

• return on capital (ROC)
• economic added value (EVA)
• free cash flow (FCF)

Question 2

which accounting measure is used when assets are on the balance sheet?

Answer 2

ROC or EVA
when most assets are tangible & on the BS, use return on capital or economic added value

Question 3

state the equation for ROC.

Answer 3

EBIT / total capital

adj op income = operating income + int. expense
total capital = long term borrowings + shareholder funds

Question 4

what does ROC actually measure?

Answer 4

indicator if return of capital actually employed and that could be put to other uses. accuracy of ROC depends on fixed assets being priced accurately at current values.

asks whether assets could earn higher return in some alternative use.

Question 5

what is economic added value?

Answer 5

complementary measure to ROC as a performance measurement.
operating profit earnt above a minimum capital charge for the use of companies assets.

Question 6

state the equation for EVA.

Answer 6

net operating income - (average capital employed * minimum required rate of return)

Question 7

why can ROC and EVA sometimes not be used as a performance measure?

Answer 7

doesn’t work with companies who have lots of assets that are not on the balance sheet. assets are often missing from balance sheet for R&D intensive firms. so need to use alternative indicators of financial performance.

Question 8

which accounting measure is used when assets are on not the balance sheet?

Answer 8

free cash flow

Question 9

what is the free cash flow model?

Answer 9

measure of the effectiveness of the firm in providing for investor returns while maintaining business growth prospects

Question 10

state the equation for free cash flow.

Answer 10

operating cash flow - (CAPEX + R&D + spending on acquisitions)

Question 11

what is the purpose of measuring financial performance?

Answer 11

1. benchmark performance. track performance overtime internally & against competitors in industry
2. design performance measures to the firms circumstances. mature firms vs highly innovative need diff measures
3. drive performance measures down to divisional level.