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


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.


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.


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


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


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


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


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


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


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


Chapter 18 12


• 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.


Chapter 18 13


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


Chapter 18 14

Motorola Segments

• Personal communications• Semiconductor products• Global Telecom Solutions• Commercial, Governmental and Industrial

Solutions• Broadband Communications• Integrated Electronics Systems• Other Products


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


Chapter 18 16

Segment Ratio Analysis

• Segment margin Segment profit (loss)/Segment revenue

• Segment EBITDA margin

revenueSegment

onAmortization DepreciatiInterest lossor profit pretax Segment


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%


Chapter 18 18


• Segment turnover Segment revenue/Segment assets

• Segment ROASegment profit/Segment assets


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


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%


Chapter 18 21


• Segment ROA – DuPont AnalysisSegment margin * Segment turnover

• Segment debt ratioSegment liabilities/Segment assets


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%


Chapter 18 23


• 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


Chapter 18 24


• 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


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)]


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%


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)


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)


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.


Chapter 18 30

Summary

• International and US standards of segment disclosures

• Evaluation of segment performance– Ratio analysis

• Residual income

• EVA®

Documents

Performance Evaluation Chapter 18 Robinson, Munter and Grant