a case of tipe of solution
ABRAMS COMAPANY
CASE 5-4 ABRAMS COMPANY
Que. 1: Evaluate each of the concerns expressed by top management, and if necessary, make recommendation appropriate to the circumtences described in the case
The Abrams case is about using profitability measures to evaluate profit centers. The case also reflects a long academic debate in the US-literature about ROI problems. In EU companies it is more common to evaluate PCs with Income measures like RI and EVA. This case covers the tree main problems in controlling profit centers:
1. The ROI behavior
2. Transfer pricing disputes
3. Operational trouble shouting
It is very difficult to find a relevant and fair capital base for the ROI measure. Abrams use
book value for fixed assets which inflate the ROI measure as the assets age.
The age and mix of assets also differs among divisions which give unfair measures. It is also easy for the divisions to manipulate the capital base at the end of the year. ROI based bonus
may rob the future, who want to invest in assets if that reduce the bonus.
I recommend this company to use RI or EVA instead of ROI and to control the investments separately using NPV and capital turnover measures. The bonus should be based on the budgeted income level, the RI target.
The problem with the inventory level can not be controlled with ROI management. If the company change to RI/EVA it will be possible to to negotiate relevant inventory levels in the budget process. High inventory levels can also be managed with differentiated capital charges
Prepared by: Milan Padariya, 63-MBA(Pharma)
Page 1
ABRAMS COMAPANY that will create high interest costs. The best way to control operational tasks is to us non financial measures such as inventory turnover.
Use non financial measures to control the inventory levels. If it is an strategic issue you can connect this measure to the bonus system.
Que. 2: What is overall evaluation of Abrams management control system?
CASE 5-4 ABRAMS COMPANY
Que. 1: Evaluate each of the concerns expressed by top management, and if necessary, make recommendation appropriate to the circumtences described in the case
The Abrams case is about using profitability measures to evaluate profit centers. The case also reflects a long academic debate in the US-literature about ROI problems. In EU companies it is more common to evaluate PCs with Income measures like RI and EVA. This case covers the tree main problems in controlling profit centers:
1. The ROI behavior
2. Transfer pricing disputes
3. Operational trouble shouting
It is very difficult to find a relevant and fair capital base for the ROI measure. Abrams use
book value for fixed assets which inflate the ROI measure as the assets age.
The age and mix of assets also differs among divisions which give unfair measures. It is also easy for the divisions to manipulate the capital base at the end of the year. ROI based bonus
may rob the future, who want to invest in assets if that reduce the bonus.
I recommend this company to use RI or EVA instead of ROI and to control the investments separately using NPV and capital turnover measures. The bonus should be based on the budgeted income level, the RI target.
The problem with the inventory level can not be controlled with ROI management. If the company change to RI/EVA it will be possible to to negotiate relevant inventory levels in the budget process. High inventory levels can also be managed with differentiated capital charges
Prepared by: Milan Padariya, 63-MBA(Pharma)
Page 1
ABRAMS COMAPANY that will create high interest costs. The best way to control operational tasks is to us non financial measures such as inventory turnover.
Use non financial measures to control the inventory levels. If it is an strategic issue you can connect this measure to the bonus system.
Que. 2: What is overall evaluation of Abrams management control system?