Performance Measurement Questions

Question 1

A project, involving an investment of $840,000 financed by an increase in the company’s loan, is under
discussion by the board of Osborne.

The project is expected to last three years, at the end of which there will be no scrap proceeds. Net cash
flows are expected as follows.
Year Flow
1 300,000
2 600,000
3 700,000
The finance director, Mr Rhodes, says “We must go for this project. It has a positive net present value
and enhances both ROI and RI of the company”.

The managing director of Osborne, Mr Iommi, whose bonus is linked to the division achieving its targets
and is due to retire at the end of next year, is not so sure.

Required:

(a) Determine whether Osborne achieved its two performance targets in the current year.

(4 marks)

(b) Assuming that (with the exception of changes resulting from acceptance of the proposed
project) the profitability and assets employed by Osborne will be constant for the
foreseeable future, show why Mr Iommi might be reluctant about accepting the project.
(6 marks)

(10 marks)

Question 2

The CP Division of Ripon had budgeted a profit before interest and tax of $3 million per year over the
period of the foreseeable future, based on a net capital employed of $10 million.
Plant replacement anticipated over this period is expected to be approximately equal to the annual
depreciation each year. These figures compare well with the organisation’s required rate of return of 20%
before tax. CP Division uses straight line depreciation.
CP’s management is currently considering a substantial expansion of its manufacturing capacity to cope
with the forecast demands of a new customer. The customer is prepared to offer a five-year contract
providing CP with annual sales of $2 million. In order to meet this contract, a total additional capacity
outlay of $2 million is envisaged, being $1.5 million of new fixed assets plus $0.5 million working capital.
A five-year plant life is expected.
Operating costs on the contract are estimated to be $1.35 million per year, excluding depreciation.
This is considered to be a low risk venture, as the contract would be firm for five years and the
manufacturing processes are well understood within CP.
Required:
Calculate the effects of accepting the contract on the CP divisional return on capital employed
(ROCE) and residual income (RI), indicating whether it would be attractive to CP’s management.

Note: ROCE and RI should be calculated for each year of the contract’s life. (8 marks)
(a) Explain the term “value analysis” in the context of cost reduction and control. (4 marks)

(b) Outline the steps involved in value analysis. (5 marks)

(9 marks)

Distinguish between the terms “cost reduction” and “cost control”. (8 marks)

Question 3

Perry is a large conglomerate company structured on a divisional basis. It seeks to maximise investor
wealth. Head office avoids day to day involvement in divisional affairs and only intervenes if
performance is considered unsatisfactory. Divisional performance is measured by residual income.
The following figures are available for Division X: ($ million):
2012 2013 2014
Capital employed 50 70 90
Operating profit 15 16 17

The cost of capital applicable to the Division X is 20% per year.

Required:
(a) Calculate the residual income for Division X for each of the three years. (3 marks)

(b) Discuss the advantages and disadvantages of residual income as a divisional performance
measure. (5 marks)

(8 marks)

Perry Hotels operates a chain of high class hotels throughout the United Kingdom. The company’s
mission statement is “To be the hotel of first choice for business users and tourists”.

Although the chain has generally been popular with tourists it is not proving quite so popular with
business users and conference organisers. Competition in the top segment of the hotel market is fierce,
with customers expecting the highest standards of facilities, service and catering.

Over the last two years the company has invested a large amount of money in modernising its hotels
including the improvement of bedrooms and public rooms, installation of gymnasiums and swimming
pools and the information technology features required by business travellers. A large amount of money
has also been spent on staff training to improve service levels and on a television advertising campaign
to promote the improved hotels to business users.

The owners of Perry Hotels are concerned that the performance of the hotel chain appears to have declined
over the last few years despite this expenditure.

Required:

(a) Explain the advantages to Perry of a balanced scorecard approach to performance

measurement. (4 marks)

(b) Suggest for each of the following headings two critical success factors suitable for the hotel
chain:

(i) financial success;

 Performance Measurement Questions

(ii) customer satisfaction;

(iii) process efficiency;
(iv) organisational learning and growth.

For each critical success factor suggest one key performance indicator suitable for the hotel chain.
(6 marks)

(10 marks)

Question 4

Heighway is a railway company. Heighway operates a passenger railway service and is responsible for
the operation of services and the maintenance of track, signalling equipment and other facilities such as
stations. In recent years it has been criticised for providing a poor service to the travelling public in terms
of punctuality, safety and the standard of facilities offered to passengers. In the last year Heighway has
invested over $20 million in new carriages, station facilities and track maintenance programmes in an
attempt to counter these criticisms. Summarised financial results for Heighway for the last two years are
given below.

Summarised profit and loss account for the year ended 31 December

2013 2014
$m $m
Sales 180·0 185·0
––––– ––––––
Earnings before interest and tax 18·0 16·5
Interest (3·2) (4·7) Tax (4·4) (3·5)
–––– ––––
Earnings available to ordinary shareholders 10·4 8·3
–––– ––––

Summarised statement of financial position as at 31 December

2013 2014
$m $m $m $m
Non-current assets
(carrying amount) 100·4 120·5
Current assets
Inventory 5·3 5·9
Receivables 2·1 2·4
Cash 6·2 3·6
–––– ––––
13·6 11·9
–––– ––––
Total assets 114·0 132·4
–––– ––––

Ordinary share capital ($1 shares) 25·0 25·0

Reserves 45·6 48·2
–––– ––––
 70·6 73·2
Non-current liabilities
8% Debenture 2019 15·0 15·0
Bank loan 20·0 35·0
–––– ––––
35·0 50·0
Current liabilities 8·4 9·2
–––– ––––
Total equity and liabilities 114·0 132·4
–––– ––––

Required:

(a) Calculate the following ratios for Heighway for 2013 and 2014, clearly showing your
workings:

(i) Return on capital employed (based on closing capital employed);

(ii) Net profit margin;
(iii) Asset turnover;
(iv) Current ratio; and
(v) Capital gearing ratio. (8 marks)

(b) Suggest TWO non-financial indicators that could be useful in measuring the
performance of a passenger railway company and state why your chosen indicators are
important. (2 marks)

(10 marks)
Question 5
Required:

(i) Briefly explain what is meant by a balanced scorecard approach to performance

measurement. (2 marks)

(ii) For each of the balanced scorecard’s perspectives on performance list TWO key
performance indicators appropriate for a state owned hospital. (4 marks)

(iii) Give FOUR advantages of using a balanced scorecard approach. (4 marks)

(10 marks)

Question 6

Mabbutt makes four types of electrical sub-assembly. The direct labour used to build the subassemblies
is highly skilled and the company sometimes has difficulties in recruitment, resulting in shortages of
labour.

The finance director considers the costs of the sub-assemblies to be too high and has considering
subcontracting their manufacture. He is also considering a cost reduction campaign to reduce the cost of
the four sub-assemblies.
 Performance Measurement Questions

Required:

Suggest SIX actions (other than subcontracting manufacture) the company could take to reduce
the cost of the sub-assemblies.
(6 marks)
Question 7

Lewisville is a town with a population of 100,000 people. The town council of Lewisville operates a bus
service which links all parts of the town with the town centre. The service is non-profit seeking and its
mission statement is “to provide efficient, reliable and affordable public transport to all the citizens of
Lewisville”. Attempting to achieve this mission often involves operating services that would be
considered uneconomic by private sector bus companies, due either to the small number of passengers
travelling on some routes or the low fares charged. The majority of the town council members are happy
with this situation as they wish to reduce traffic congestion and air pollution on Lewisville’s roads by
encouraging people to travel by bus rather than by car.

However, one member of the council has recently criticised the performance of the Lewisville bus service
as compared to those operated by private sector bus companies in other towns. She has produced the
following information:

Lewisville Bus Service

Summarised Income and Expenditure Account Year ending 31 December 2014
$000 $000
Passenger fares 1,200
Staff wages 600
Fuel 300
Depreciation 280
––––– 1,180
–––––
Surplus 20
–––––
Summarised statement of financial position as at 31 December 2013
$000 $000
Non-current assets (carrying amount) 2,000
Current assets: Inventory 240
Cash 30
–––– 270
–––––
Total assets 2,270
–––––

Ordinary share capital ($1 shares) 2,000

Reserves 210
–––––
2,210
Current liabilities: Payables 60
–––––
 2,270
–––––
Operating statistics for the year ended 31 December 2014

Total passengers carried 2,400,000 passengers

Total passenger kilometres travelled 4,320,000 passenger kilometres

Private sector bus companies: Industry average ratios – Year ended 31 December 2014
Return on capital employed 10%
Return on sales (net margin) 30%
Asset turnover 0·33 times
Average cost per passenger km 37·4c

Required:

(a) Calculate the following ratios for the Lewisville bus service

(i) Return on capital employed (based upon opening investment);

(ii) Return on sales (net margin);
(iii) Asset turnover;
(iv) Average cost per passenger kilometre. (4 marks)

(b) Another council member suggests that the performance of the bus service should be assessed
on the basis of economy, effectiveness and efficiency.

Required:

Explain the meaning of the following terms in the context of performance measurement
and suggest a measure of each one appropriate to a bus service.

(i) Economy;
(ii) Effectiveness;
(iii) Efficiency. (6 marks)

(10 marks)