24.2.5: Comparing Performance Measures

Comparing Performance Measures

The following table summarizes the performance of each hotel and ranks it (in parentheses) under each of the four performance measures:

A table shows the performance of each hotel and ranks it (in parentheses) under each of the four performance measures

The table depicts return on investment, residual income, economic value added, and return on sales for hotels in San Francisco, Chicago, and New Orleans. The details of the table are as follows:

1. San Francisco

Return on investment: 24 percent, rank 1
Residual income: 120,000 dollars, rank 2
Economic value added: 68,250 dollars, rank 2
Return on sales: 20.0 percent, rank 2

2. Chicago

Return on investment: 15 percent, rank 3
Residual income: 60,000 dollars, rank 3
Economic value added: 15,750 dollars, rank 3
Return on sales: 21.4 percent, rank 1

3. New Orleans

Return on investment: 17 percent, rank 2
Residual income: 150,000 dollars, rank 1
Economic value added: 73,500 dollars, rank 1
Return on sales: 16.0 percent, rank 3

The RI and EVA rankings are the same. They differ from the ROI and ROS rankings. Consider the ROI and RI rankings for the San Francisco and New Orleans hotels. The New Orleans hotel has a smaller ROI, indicating that its assets are being used relatively less efficiently. Although its operating income is only slightly more than twice the operating income of the San Francisco hotel—$510,000 versus $240,000—its total assets are three times as large—$3 million versus $1 million. However, the New Orleans hotel has a higher RI because it earns a higher income after covering the required rate of return on investment of 12%. Even though each dollar invested in the New Orleans hotel does not yield the same return as the San Francisco hotel, this large investment creates considerable value because its return exceeds the required rate of return. The Chicago hotel has the highest ROS but the lowest ROI. The high ROS indicates that the Chicago hotel has the lowest cost structure per dollar of revenues of all of Hospitality Inns’ hotels. Chicago has a low ROI because it generates very low revenues per dollar of assets invested.

Is any method better than the others for measuring performance? No, because each method evaluates a different aspect of performance. ROS measures how effectively costs are managed. To evaluate a unit’s overall aggregate performance, however, ROI, RI, or EVA measures are more appropriate than ROS because they consider both income and investment. ROI indicates which investment yields the highest return. RI and EVA overcome some of the goal-congruence problems of ROI. Some managers favor EVA because of the accounting adjustments related to the capitalization of investments in intangibles. Other managers favor RI because it is easier to calculate and because, in most cases, it leads to the same conclusions as EVA does. Generally, companies use multiple financial measures to evaluate performance.