Question

Jennifer Baskiter is the president and CEO of Plants & More.com, an Internet company that sells plants and flowers. The success of her startup Internet company has motivated her to expand and create two divisions. One division focuses on sales to the general public and the other focuses on business-to-business sales to hotels, restaurants, and other firms that want plants and flowers for their businesses. She is considering using return on investment as a means of evaluating her divisions and their managers. She has hired you as a compensation consultant.

Required:
What issues or concerns would you raise regarding the use of ROI for evaluating the divisions and their managers?

Answer 1

Answer: It can lead to dysfunctional decision making.

Step-by-step explanation:

It may lead to a dysfunctional decision making. For example, a division with a current ROI of 30% will not wish to accept a project that offers a ROI of 25%, because it would dilute the current figure it has. However, the 25% ROI may be able to meet or exceed the company’s target.

Return on investment (ROI) increases with the asset age if the net book value (NBV) is used, thereby giving managers incentive to hang on to possibly obsolescent and inefficient machines. It may also encourage the manipulation of the profit and the capital employed figures to improve results, e.g to obtain a bonus payment. The use of different accounting policies can lead to confusion in comparisons e.g. depreciation policy.