Case Study : 7-3 Quality Metal Servce Center CASE STUDY : 7-3 QUAlLITY METAL SERVCE CENTER Q1.

Is the capital investment proposal described in Exhibit 3 an attractive one for Quality Metal Service Center? Yes, the purpose of a company is to maximum the profit, and as Elizabeth Barret suggested,it can help company to make more profit. So the capital investment pro posal described in Exhibit 3 is an attractive on for QMSC. Investment in machine $540,000 10 years cash inflow $286,000 PV of cash inflow $39,182 Payback period = 4.5 years NPV= 286000 IRR= 2.8% Reasons for selection: * Positive cash flow * IRR> COC * Payback period is less than the standard Q 2: Should Ken Richards send that proposal to home office for approval? Ken need send this proposal to home office for approval, because this proposal i s good for the company and can make a lot of profit for the company. And another reason is, capitalexpenditures in excess of $10,000 and all capital leasing dec isions require corporate approval. Q 3: Comment on the general usefulness of ROA as the basis of evaluating distric t managers performance. Could this performance measure be made more effective? The Return on Assets (ROA) percentage shows how profitable a company's assets ar e ingenerating revenue.An indicator of how profitable a company is relative to i ts total assets.ROA gives an idea as to how efficient management is at using its assets to generate earnings. ROA can be computed as Net Income/ Total Assets.To make it more effective QMSC can use: Multiple performance measure, managementse rvice histories, or strategy paining. Q 4: In deciding the investment base for evaluating managers of investment cente rs, thegeneral question is:What practices will motivate the district mangers to use their assets most efficiently andto acquire the proper amount and kind of ne w ssets? Presumably, when his redesirethat the actions he takes toward this end be actions that are in the best interest of thewhole corporation. Given this gen eral line of reasoning, evaluate the way Quality computes the investment base fo r its districts.For each asset category, discusswhether the basis of measurement used by the company is the best for the purpose of measuring districts return o

n assets.What are the likely motivational problems thatcould arise in such a sys tem? What can you recommend to overcome such dysfunctionaleffects? Yes, in the investment center. The managers are responsibility for the segments, investmentand asset base as well as the profits. Usually, evaluate based on the return on assetsemployed, evaluation might include a variety of measures such as profit, return oninvestment, residual income, economical valued added and a ran ge of non-financialmeasures. Hence the manager in the districts should consider about the acquisition of newequipment which is an investment for the segment. An d also, they evaluated equipments andaccounts receivable etc. based on the retur n on assets employed. May be it can also be the profit center because the manage rs usually evaluated in terms of effectiveness in raisingsegment profit level an d controlling costs.QMSC should use EVA instead of ROA as the measure of distric t and manager performance. Since EVA is the best proxy for shareholder value at the business unit level, improving EVA will also improve the companys overall pe rformance. The managers district objectives will then be congruent with the comp anys overall objectives. This will induce Mr. Richards to employ additional asse ts which will promote the growth of both the Columbus district and QMSC, such as the one in Ms. Barret s proposal. The purchase of the new processing equipment is also in line with the company s objective to develop techniques and marketing pro gram that would increase market share inidentified industries and geographic mar kets of specialty metal users. Having the equipmentwill allow QMSC to provide th e demand for processed metals in the Columbus District witha short lead time, ad dressing the concern of potential customers. Another aspect of the issue that ne eds to be looked into is the decision on what assets should be included in the i nvestment base and what expenses should be charged from profits. QMSCincludes la nd, warehouse buildings, and equipment at gross book value in its investment bas e.This results to an EVA that signals a decrease in profitability during the ear ly years of the assets when in fact, profits increased. It will be better for th e company to use annuitydepreciation so that the profitability calculations will show the correct EVA. Leased buildings and equipment are also part of the asset base. This motivates managers to leaserather own assets whenever the interest c harge that is built into the rental cost is less than thecapital charge that is applied to the investment base. Thus, the head office must think carefully befor e approving the leases of the districts as the managers might just be using it t owindow dress their performance. QMSC also includes inventory and accounts recei vables,without subtracting standard accounts payable, using average values for t he period. This is agood practice because these are representative of the assets used during the period and thus,conceptually a satisfactory measure of the amou nt that should be related to profits. Q 5: While computing district profits for performance evaluation purposes, shoul d therebe a charge for income taxes? Should corporate overheads be allocated to districts? Should profits be computed on the basis of historical costs or on the basis of replacement costs? Evaluate these issues from the standpoint of their motivationalimpact on the district managers?

No, while computing district profits for performance evaluation purpose did not charge for income taxes, for each district was calculated based on current inven tory replacement values.Expenses were separated into controllable and non contro llable categories. No corporateoverhead expenses were allocated to the districts . A few years earlier, the company hadconsidered a proposal to allocate corporate overheads to the districts. However, the proposalhad been rejected on the ground s that the allocation bases were arbitrary and that suchexpenses could not be co ntrolled at the district level. So profit should be computed on the basis of his torical costs and performance. The motivational impact on the district mangersth

at thing before taking corporate overheads. Q 6 :Evaluate Quality s incentive compensation system . Does the present systemmot ivate district managers to make decisions which are consistent with the strategy of the firm? If not, make specific recommendations to improve the system? The key issue in the case is that the incentive compensation system does not mot ivate district managers to make decisions which are consistent with the strategy of Quality Metal ServiceCenter (QMSC) because it is tied to the district s target ROA. Acquiring the new processingequipment reduces the incentive bonus of the C olumbus District Manager, Mr. Ken Richards,from 11.1% to 4.28% of his base salar y. This happens because the asset base increases withthe new equipment and will exceed the target for 1992. This may motivate him to not proceedwith the purchas e even if the proposal of the Sales Manager, Ms. Elizabeth Barret, shows thatthe acquisition results to a positive NPV and thus, should be sent to the home offi ce for approval.