Advanced Performance Management · Performance optimisation in specific contexts

Performance Management in Divisionalised and Multinational Firms

Updated 11 October 2026 · Fact-checked

Divisional performance management judges managers and divisions using measures such as ROI and residual income, with transfer prices setting the value of internal trades. In multinationals you must also consider exchange rates, tax, regulation and culture. Solve questions by computing, then evaluating controllability, goal congruence and behaviour.

Understand Performance Management in Divisionalised and Multinational Firms

A divisionalised firm gives managers authority over a part of the business. Head office then needs a way to judge whether each division, and each manager, is doing well. That is the core problem in this topic.

The usual measures are ROI (return on investment) and residual income (RI). ROI is a percentage, so it is easy to compare divisions. But it can make managers reject projects that earn more than the group's cost of capital, because the project lowers the division's average ROI. RI deducts a capital charge, so any project earning above the cost of capital raises RI. This gives better goal congruence. RI is an absolute amount, so it favours larger divisions.

Transfer pricing is the price charged when one division sells to another. It moves profit between divisions, so it affects the measures above and the manager's behaviour. A good transfer price supports goal congruence, fair performance assessment, divisional autonomy and group profit. A common general rule is: minimum transfer price = marginal cost + opportunity cost to the group of making the transfer. The maximum the buyer will pay is the lower of the net marginal revenue and the external buying price.

Multinationals add complexity. Exchange rates change reported results, so you must separate real performance from currency movements. Tax differs by country, so groups may set transfer prices to move profit to low-tax countries. Tax authorities may challenge this, and it can distort divisional measures. Other issues include import duties, restrictions on remitting profits, inflation, different accounting rules and cultural differences that affect how targets and rewards are received.

In the exam, the marks are in evaluation. Compute the figures, then say what they mean for behaviour, fairness and group interest, and recommend changes using the scenario's facts.

Key rules to remember

Return on investment (ROI): ROI = divisional profit ÷ capital employed × 100%; State which profit and capital measure you use, for example controllable profit and net assets. Be consistent.
Residual income (RI): RI = divisional profit − (capital employed × cost of capital); Accept a project if it gives positive RI at the group's required return.
Minimum transfer price: Minimum price = marginal cost of the selling division + opportunity cost to the group; With spare capacity the opportunity cost is nil. With full capacity it is the contribution lost on external sales.
Maximum transfer price: Maximum price = lower of net marginal revenue to the buyer and the external price for the input; Net marginal revenue is the final selling price less the buyer's further processing costs.
Foreign currency translation: Home currency amount = foreign amount ÷ rate quoted as foreign per home unit, or × rate quoted as home per foreign unit; Check how the rate is quoted before converting.

How to solve Performance Management in Divisionalised and Multinational Firms questions

Use this order for any question on divisional or multinational performance. It keeps the calculation short and leaves time for the evaluation that earns the marks.

1Read the requirement and identify the task: calculate, evaluate, advise or discuss. Note the professional role you are asked to play.
2Identify the structure: who controls what, and whether divisions trade with each other or across borders.
3Calculate the measures asked for, such as ROI, RI or transfer price limits. State your assumptions on profit and capital.
4Interpret the figures: compare divisions, compare with the cost of capital and ask which decisions each measure would encourage.
5Test for controllability: remove costs or assets the manager cannot control, such as head office charges or imposed investment.
6For multinational points, deal with exchange rates, tax, regulation and culture, tying each to the scenario.
7Link to behaviour: goal congruence, autonomy, motivation and dysfunctional actions.
8Conclude with a clear recommendation and mention any limits, such as missing data.

Quickest way: Calculate, behave, recommend

When to use it: Use it when time is short or the question is worth few marks. It gives a short structured answer.

Write ROI and RI for each division in a small list.
Say which project or division each measure favours, and whether that matches group interest.
For a transfer price, write the minimum and maximum limits and say whether a mutually beneficial range exists.
Add one scenario-specific point on tax, currency or culture.
End with one recommendation, such as using RI or setting a negotiated price.

Common mistakes in Performance Management in Divisionalised and Multinational Firms

Stating that a higher ROI always means a better division.
ROI is easy to read as a score.
Fix: Compare ROI with the cost of capital and show that a high ROI can lead managers to reject worthwhile projects.
Using the wrong capital charge in RI, such as applying it to profit rather than capital employed.
Students rush the formula.
Fix: Write RI = profit − capital employed × cost of capital, then compute the charge on its own line.
Ignoring opportunity cost when finding the minimum transfer price.
Students stop at marginal cost.
Fix: Check whether the seller has spare capacity. If not, add the contribution lost on external sales.
Treating transfer pricing as only a tax issue in a multinational.
The tax angle is memorable.
Fix: Cover performance measurement and motivation as well as tax. Note that tax authorities may challenge the price.
Comparing overseas divisions without adjusting for exchange rates or inflation.
Figures are taken as given.
Fix: Say that results should be compared in a common currency, and consider local currency and constant-rate measures.
Giving a list of generic points with no link to the scenario.
Students recall theory rather than apply it.
Fix: Use the scenario's figures, countries and managers in every point to earn application and professional skills marks.

Worked examples

Example 1

Division A has profit of $240,000 and capital employed of $1,200,000. Division B has profit of $450,000 and capital employed of $3,000,000. The group cost of capital is 12%. Calculate ROI and RI for each division and comment. Division A can invest in a project costing $200,000 that earns $26,000 a year.

Show the solution

Division A ROI = 240,000 ÷ 1,200,000 = 20%.
Division B ROI = 450,000 ÷ 3,000,000 = 15%.
Division A RI = 240,000 − (1,200,000 × 12%) = 240,000 − 144,000 = $96,000.
Division B RI = 450,000 − (3,000,000 × 12%) = 450,000 − 360,000 = $90,000.
Project return = 26,000 ÷ 200,000 = 13%, which is above the 12% cost of capital.
New ROI for A = (240,000 + 26,000) ÷ (1,200,000 + 200,000) = 266,000 ÷ 1,400,000 = 19%.
This is below 20%, so an ROI-based manager may reject the project.
New RI for A = 96,000 + 26,000 − (200,000 × 12%) = 96,000 + 26,000 − 24,000 = $98,000, an increase of $2,000.

Answer: ROI: A 20%, B 15%. RI: A $96,000, B $90,000. The project raises RI by $2,000 but cuts A's ROI from 20% to 19%. Using RI encourages the manager to accept it, which is in the group's interest.

Example 2

Division X makes a component with marginal cost of $30. It sells externally at $50 and sells everything it can make. Division Y wants to buy the component. Y could buy it externally for $48. Y's net marginal revenue from using the component is $55. Find the range for a transfer price and advise on it if X has spare capacity and if X has no spare capacity.

Show the solution

With no spare capacity, X loses the external sale, so opportunity cost is the lost contribution: 50 − 30 = $20.
Minimum transfer price with no spare capacity = 30 + 20 = $50.
Maximum transfer price = lower of net marginal revenue ($55) and external price ($48) = $48.
Minimum $50 is above maximum $48, so no mutually beneficial range exists. Y should buy externally at $48.
With spare capacity, opportunity cost is nil, so the minimum is $30.
The range is then $30 to $48. Any price in it benefits the group, since the transfer is at cost $30 against an external cost of $48 saved.

Answer: No spare capacity: minimum $50, maximum $48, so no transfer; Y buys externally. Spare capacity: range $30 to $48, so the transfer should go ahead at a negotiated price in that range.

Exam tips

Always show the calculation and then evaluate. Marks are mainly for the comment, not for the arithmetic.
Quote the scenario's facts, such as countries, tax rates or manager behaviour, when you discuss multinational issues.
Write short sub-headed answers when asked for a report. This helps the professional skills marks for communication and structure.
State your assumptions on profit, capital and exchange rates when the data is unclear. Examiners reward sensible, stated choices.
Offer a recommendation, not only a list. Say which measure or transfer pricing method you would use and why.

Practice questions from Performance optimisation in specific contexts

Performance Management in Divisionalised and Multinational Firms: frequently asked questions

Is ROI or RI better for divisional performance?

Neither is always better. RI gives better goal congruence for investment decisions because any project above the cost of capital raises it. ROI is useful for comparing divisions of different sizes. In the exam, discuss both and use the scenario to justify a choice.

How do I find the minimum transfer price in APM?

Add the selling division's marginal cost to the opportunity cost to the group of making the transfer. With spare capacity the opportunity cost is nil. At full capacity it is the contribution lost from external sales.

How do exchange rates affect divisional performance?

Exchange rate movements change reported profit and capital employed when overseas results are translated. They can make a division look better or worse for reasons the manager cannot control. You should separate currency effects from real operating performance.

Why do multinationals use transfer pricing for tax?

Transfer prices decide where profit appears in the group, so a group may be tempted to shift profit to lower-tax countries. Tax authorities can challenge prices that are not at a fair market level. Such manipulation can also distort divisional performance measures.