Show the demerits of using return on investment, Strategic Management

Q. Show the Demerits of using return on investment?

The following disadvantages maybe experienced when choosing to use ROI as a primary performance measure.

-  An accounting not cash-based measure. A company with old noncurrent assets that are almost completely depreciated will show a high ROI/ROCE, whereas a company with recently acquired noncurrent assets will show a low ROI/ROCE.  Different accounting policies will also give different ratios, for example using the historical cost model or re-valuation model to measure capital employed, also different stock valuation or depreciation policies can materially affect the size of capital employed.

-  The age of (or investment cycle) of non-current assets is important in understanding the ROCE/ROI ratio. Recently acquired noncurrent assets will not be generating revenues to their full extent. ROCE/ROI can act as a disincentive to invest by a manager, because new investment often delivers low profitability and high accounting book value, in the early years of investment.  This can discourage managers in the short-term from undertaking investment because a low ROCE/ROI will be harmful to their performance measurement. The long-term effect is goal incongruent decisions being made e.g. investment which is essential maybe delayed, the long-term consequences inefficiency and higher cost in future.

-  Such methods can create short-term behaviour by divisional managers. Under investment in non-current assets causes the accounting net book value to decrease over time.  If profits remain fairly static in the short-term, ROCE/ROI will improve, yet the manager has done very little in terms of improving performance.  ROCE/ROI improves over the life of an asset where little or no reinvestment has taken place.  Managers may also be over zealous when cutting back expenditure in order to improve profit e.g.  Cutting back on advertising, staff training etc., such rationalisation programmes can jeopardise the long-term profit of the business.  

-  ROI may create political arguments over such costs as head office apportioned overhead or interest charges by head office that have negative impact on ROCE/ROI. "Controllability principle" is concerned with assessing performance based upon measures which can be controlled only by a manager and neglecting any items which are uncontrollable.

Posted Date: 8/9/2013 1:45:27 AM | Location : United States

Related Discussions:- Show the demerits of using return on investment, Assignment Help, Ask Question on Show the demerits of using return on investment, Get Answer, Expert's Help, Show the demerits of using return on investment Discussions

Write discussion on Show the demerits of using return on investment
Your posts are moderated
Related Questions
Q. Show the Cost based approaches - Method of transfer pricing? The pricing of products or services are based on their full or variable (marginal) production cost per unit. Ful

Which is more important in explaining the success or failure of companies: strategising or luck?

Question 1: (a) Explain a framework for a company to manage its application portfolio. (b) Apply the application portfolio concept to show the different applications for a

Q. Explain about Residual income? Residual income is profit earned by a division less a "notional interest charge" for investment of finance within it.

1. Find one research article entitled 'Using the balance scorecard as a strategic management system' attached here with. Read this article carefully and give your comments. You may

VRC is a family owned business which has been manufacturing racing cycles for over a century. Over the years, the company has been relatively successful, although its growth has te

Fixing the Knowledge Gap: Planning  Now commence the 'Fixing knowledge gap' phase by identifying the broad nature of the solution required, as follows:  a)  Wherever you h

S Company has for many years been a long standing household name, designing and manufacturing electrical appliances for use in the kitchen. It has developed a strong culture over t

1. Run the Heterogeneous Catalysis simulator for different initial conditions (initial partial pressures of species A, B, C, and D) to get the reaction rates; 2. Study the influ

An industrial accident may be defined as "an occurrence. Which interrupts or interferes with the orderly progress or work in an industrial establishment." According to the Facto