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Financial Management



                      Notes


                                       Notes  The importance of management information system has increased in recent times
                                       because of the following:
                                       1.  Emergence of global economy
                                       2.  Transformation  of  industrial  economics  –  knowledge  and information  intense
                                           products have become available.
                                       3.  Transformation of multinational enterprises
                                       4.  Emergence of digital form.


                                           Example:A division has a budgeted income of   10 lakhs and a budgeted investment of
                                      60 lakhs. The average cost of capital for the firm is 12 per cent. The budgeted residual income
                                    is:
                                           Divisional Income                             10 lakhs

                                           Interest charge
                                           12% on   60 lakhs                           7.20
                                           Residual income/ Economic value added       2.80

                                         !

                                       Caution  Different interest rates may be applied to different components of investment like
                                       fixed assets, inventories, receivables and cash.

                                    During the 1990s, residual income has been refined and remained as Economic Value  Added
                                    (EVA) by Stern Steward Counseling Organization and they have registered EVA (TM) as their
                                    trademark.
                                    The EVA concept extends the traditional residual income measures by incorporating adjustments
                                    to the divisional performance measures against distortions introduced by generally accepted
                                    accounting principles (GAAP).
                                               EVA can be defined as = Conventional  divisional  profit  ±  Accumulated
                                                                     adjustment – Cost of capital charge on divisional assets.

                                    Adjustments are  made to  the chosen,  conventional divisional  profit  measures in  order  to
                                    replace historical accounting data with a measure of economic profit and asset values. Stern
                                    Stewart  has developed  approximately  160  accounting adjustments  but most  organisations
                                    will only need to use about 10 of the adjustments. These adjustments result in the capitalization
                                    of  many  discretionary  adjustments  such  as  research  and  development,  marketing  and
                                    advertising by  spreading these costs over  the periods in  which  the  benefits  are  received.
                                    Therefore, adopting EVA reduces some of the harmful side effects arising from using financial
                                    measures. Also, because it is restatement of the residual income measure compared to ROI,
                                    EVA is more likely to encourage goal congruence in terms of asset acquisition and disposal
                                    decisions. Managers are also made aware that capital has a cost and they are thus encouraged
                                    to dispose of underutilized assets that do not generate sufficient income to cover their cost of
                                    capital. There are a number of issues that apply to ROI, residual income or its replacement
                                    (EVA). They concern determining which assets should be included in a divisions asset base





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