Professional Documents
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What is Divisionalisation?
Divisionalisation is the situation where managers of business areas are given a
degree of autonomy over decision making i.e. they are given the authority to make
decision without reference to senior management. In effect they are allowed to run
their part of the business almost as though it were their own company.
Advantages
Disadvantages
Specialism in
Coordination difficulties
product/country/customer
established
dysfunctional decision-making
divisions to be compared
divisions.
ROCE
Able to compare divisions of
different sizes
It can be broken down into
secondary ratios
For more detailed analysis, profit
& asset
turnover
decision making
Increases with age of asset if
NBV are used
Different accounting policies can
confuse
comparisons
Example
Balaka plc has divisions throughout the Nyasa States. The Liwonde division is
currently making a profit of MK82, 000 p.a. on investment of MK500, 000. Balaka
has a target return of 15%. The manager of Liwonde is considering a new
investment which will require additional investment of MK100, 000 and will
generate additional profit of MK17, 000 each year/
(a) Calculate whether or not the new investment is attractive to the company as a
whole.
(b) Calculate the ROI of the division, with and without the new investment and
hence determine whether or not the manager would decide to accept the new
investment.
The circumstances are the same as in example 1, except that this time the manager
of the Liwonde division is considering an investment that has a cost of MK100, 000
and will give additional profit of MK16, 000 p.a.
(a) Calculate whether or not the new investment is attractive to the company as a
whole.
(b) Calculate the ROI of the division, with and without the new investment and
hence determine whether or not the manager would decide to accept the new
investment.
In this example the manager is not motivated to make a goal congruent decision.
For this reason, a better approach is to assess the managers performance on
Residual Income.
2. Residual Income (RI)
MK
RI = Controllable profit from operations
XXXXX
Less: Imputed interest (controllable capital employed X Cost of capital)
XXXXX
XXXXX
Note: used PBIT if profit from operations is not given
Advantages
Disadvantages
Reduces problems of ROI i.e.
Difficult to decide upon an
dysfunctional behavior and
appropriate cost of capital
Disadvantages
Numerous adjustments to profit
and capital employed figures
which can be cumbersome
Does not facilitate comparisons
btwn divisions since EVA is an
absolute measure (as is RI)
Many assumptions made when
calculating the WACC, making its
calculations difficult and
potentially inaccurate
Based on historical data whereas
shareholders are interested in
future performance
Balance Sheets:
2014
MK
Non-current assets
Net current assets
Financed by:
Shareholders funds
Medium and long-term bank loans
250
256
506
380
126
506
2013
MK
192
208
400
312
88
400