Performance Evaluation Chapter 18 Robinson, Munter and Grant.
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Transcript of Performance Evaluation Chapter 18 Robinson, Munter and Grant.
Performance Evaluation
Chapter 18
Robinson, Munter and Grant
Robinson, Munter & Grant
Chapter 18 2
Learning Objectives
• Segment reporting
• Segment performance evaluation
• US and international standards
• Residual Income
• Economic Value Added
Robinson, Munter & Grant
Chapter 18 3
IAS 14 Segments
• Business segment: Distinguishable component of an enterprise providing an individual product or service or group of related products or services.
• Geographic segment: Components of a consolidated entity that provide goods or service within a particular economic environment.
• One will be primary the other secondary, depending on the entity’s dominant source of risk and returns.
Robinson, Munter & Grant
Chapter 18 4
Reportable SegmentsIAS 14
• Segment revenue is at least 10% of total revenue for the firm;
• Segment result, profit or loss, is at least 10% of total profit or loss; or
• Assets are at least 10% of total assets.
Robinson, Munter & Grant
Chapter 18 5
Reportable SegmentsIAS 14
• Segments below the 10% threshold may be disclosed or aggregated with other segments
• Reported segments must represent at least 75% of consolidated revenues
Robinson, Munter & Grant
Chapter 18 6
Required Segment DisclosuresPrimary segments – IAS 14
• Segment revenue• Segment result
– Exclude extraordinary items, interest expense, income tax expense, certain losses and corporate-level expenses
• Carrying amount of segment assets• Segment liabilities• Segment asset acquisitions
Robinson, Munter & Grant
Chapter 18 7
Required Segment DisclosuresPrimary segments – IAS 14
• Segment depreciation and amortization
• Other significant segment noncash expenses
• Segment profit or loss from equity investments
• Reconciliation of segment amounts to consolidated amounts
Robinson, Munter & Grant
Chapter 18 8
Required Segment DisclosuresSecondary segments – IAS 14
• When primary segment is business• Secondary segment is Geographic and must
report– Segment (external) revenue by geographic area– Segment assets by geographic location of assets– Acquisitions of segment assets by geographic
location– Apply 10% threshold
Robinson, Munter & Grant
Chapter 18 9
Required Segment DisclosuresSecondary segments – IAS 14
• When primary segment is geographic
• Secondary segment is Business and must report– Segment (external) revenue– Segment assets– Acquisitions of segment assets
Robinson, Munter & Grant
Chapter 18 10
Reportable SegmentsSFAS 131
• Operating segments are– A component of an enterprise engaged in
business activity for which it may earn revenues and incur expenses, about which separate financial information is available that is evaluated regularly by decision makers…
• Same 10% and 75% thresholds apply
Robinson, Munter & Grant
Chapter 18 11
Required Segment DisclosuresOperating segments – SFAS 131
• General information about segments and their identification
• Segment profit and loss and additional income statement items
• Segment assets
Robinson, Munter & Grant
Chapter 18 12
Required Segment DisclosuresOperating segments – SFAS 131
• Reconciliation to corporate amounts
• Information about products, services and geographic areas
• Revenues from major customer if 10% or more of revenues is derived from there.
Robinson, Munter & Grant
Chapter 18 13
Required Segment DisclosuresOperating segments – SFAS 131
Additional income statement information
• External revenues• Internal revenues• Interest revenue• Interest expense• Depreciation,
depletion, and amortization
• Other significant non-cash items
• Unusual items• Equity method income• Income tax expense or
benefit• Extraordinary items
Robinson, Munter & Grant
Chapter 18 14
Motorola Segments
• Personal communications• Semiconductor products• Global Telecom Solutions• Commercial, Governmental and Industrial
Solutions• Broadband Communications• Integrated Electronics Systems• Other Products
Robinson, Munter & Grant
Chapter 18 15
Motorola Segments Segment descriptive information
• Principal products and services
• Industry• Strategy• Customers• Competition
• Payment terms• Backlog• Intellectual property
Inventory, Raw materials, Right of return and Seasonality
• Facilities
Robinson, Munter & Grant
Chapter 18 16
Segment Ratio Analysis
• Segment margin Segment profit (loss)/Segment revenue
• Segment EBITDA margin
revenueSegment
onAmortization DepreciatiInterest lossor profit pretax Segment
Robinson, Munter & Grant
Chapter 18 17
Segment Ratio AnalysisMotorola Segment Margin
2001 2000 1999
Personal Communication -17.2% -2.5% 5.1%
Global Telecommunicat -21.6% 10.9% -7.3%
Commerc/Government 11.8% 9.5% 15.0%
Broadband Communicat -15.3% 36.6% 11.6%
Semiconductor Products -43.4% -2.1% 8.4%
Integrated Electronics -9.4% 6.4% 7.4%
Other Products 73.0% -32.0% -78.6%
Robinson, Munter & Grant
Chapter 18 18
Segment Ratio Analysis
• Segment turnover Segment revenue/Segment assets
• Segment ROASegment profit/Segment assets
Robinson, Munter & Grant
Chapter 18 19
Segment Ratio AnalysisMotorola Segment Turnover
2001 2000 1999
Personal Communication 2.35 1.60 1.86
Global Telecommunicat 1.41 1.19 0.88
Commerc/Government 2.08 1.46 1.62
Broadband Communicat 0.84 0.83 0.76
Semiconductor Products 0.65 0.85 0.94
Integrated Electronics 1.98 2.16 2.25
Other Products 0.41 0.29 0.29
Robinson, Munter & Grant
Chapter 18 20
Segment Ratio AnalysisMotorola Segment ROA
2001 2000 1999
Personal Communication -40.4% -4.0% 9.5%
Global Telecommunicat -30.5% 12.9% -6.5%
Commerc/Government 24.5% 13.8% 24.3%
Broadband Communicat -12.8% 30.3% 8.8%
Semiconductor Products -28.4% 1.8% 7.9%
Integrated Electronics -18.7% 13.9% 16.7%
Other Products 30.2% -9.4% -22.7%
Robinson, Munter & Grant
Chapter 18 21
Segment Ratio Analysis
• Segment ROA – DuPont AnalysisSegment margin * Segment turnover
• Segment debt ratioSegment liabilities/Segment assets
Robinson, Munter & Grant
Chapter 18 22
Segment Ratio Analysis Nokia Segment Debt Ratio
2001 2000
Networks 38.1% 38.1%
Mobile Phones 80.0% 64.7%
Ventures 108.8% 36.1%
Robinson, Munter & Grant
Chapter 18 23
Segment Ratio Analysis
• Use of the equity method can distort operating margins
• Equity earnings represent the share of profits or losses from unconsolidated investments of significant influence
• Equity earnings (loss) return:Equity earnings or loss/Equity investments
Robinson, Munter & Grant
Chapter 18 24
Segment Ratio Analysis
• Additional considerations when comparing segments of different firms
– Differences in accounting practices/standards– Definition of segments may vary– Currency differences are alleviated when
ratios are used in comparative analyses
Robinson, Munter & Grant
Chapter 18 25
Residual Income
• Net income – dollar cost of equity– Dollar cost of equity =
Cost of equity ($) * cost of equity (%)
• Is negative when ROE<Cost of equity (%)
• [(EBIT (1-tax rate)) – (Assets*WACC)]
Robinson, Munter & Grant
Chapter 18 26
Residual IncomeMotorola example
Pretax income $ 1,168
Tax rate 30%
Stockholders’ equity (book value) $ 16,828
(75.1%)
Debt (long- and short-term) $ 5,593
(24.9%)
Total capital $ 22,421
Cost of equity (CAPM) 12.8%
Cost of debt 7.0%
Robinson, Munter & Grant
Chapter 18 27
Residual IncomeMotorola example
• WACC = 10.83%(.07 * (1-.3) * .249) + (.128 * (.751))
• Residual income = ($1,611)($1,168(1-.3)) – ($22,421*.1083)
Robinson, Munter & Grant
Chapter 18 28
Economic Value Added
• Developed by Stern Stewart & Company
• EVA® = NOPAT – C%(TC)– NOPAT = Net operating profits after taxes
• Adjustments are made to arrive at an economic (rather than GAAP) measure of earnings
– C% = Cost of capital– TC = Total capital employed
• Motorola’s 1999 EVA® = ($1,170)
Robinson, Munter & Grant
Chapter 18 29
Residual Income and Security Selection
• Will firms that use residual income measures for evaluation internally have better shareholder returns?
• Can a residual income approach be used to improve an investor’s selection of securities?
• Research on these issues is mixed.
Robinson, Munter & Grant
Chapter 18 30
Summary
• International and US standards of segment disclosures
• Evaluation of segment performance– Ratio analysis
• Residual income
• EVA®