STRATEGIC PERFORMANCE MANAGEMENT QUESTION BANK II QUESTION 1 Transfer Pricing Divisional Companies tend to operate a transfer pricing system in order to sell goods from one division to another division within the same company. The transfer pricing system operated by a divisional company has the potential to make a significant contribution towards the achievement of corporate financial objectives. Required: What are the potential benefits of operating a transfer pricing system within a divisionalised company? (12 marks) Roche Ltd has been offered supplies of special ingredient Z at a transfer price of 15 per kg by State Ltd which is part of the same group of companies. State Ltd processes and sells special ingredient Z to customers external to the group at 15/kg. State Ltd bases its transfer price on cost plus 25% profit mark-up. Total cost is estimated as 75% variable and 25% fixed. There is a 1.50 packaging cost for external sales. Required: Discuss the transfer prices at which State Ltd should offer to transfer special ingredient Z to Roche Ltd in order that group profit maximizing decisions may be taken on financial grounds in each of the following situations: State Ltd has an external market for all of its production of special ingredient Z at a selling price of 15 per kg. Internal transfers to Roche Ltd would enable 1.50 per kg of variable packing cost to be avoided. (6 marks) Conditions are as per (i) but State Ltd has production capacity for 3000kg of special ingredient Z for which no external market is available. (3 marks) Conditions are per (ii) but State Ltd has an alternative use for some of its spare production capacity. This alternative use is equivalent to 2000kg of special ingredient Z and would earn a contribution of 6,000. (4 marks) Total (25 marks) QUESTION 2 Animals R Us Limited is a company which offers care and supervision for pet animals whose owners are not able to look after their animals for short periods of time, whether due to work commitments or holidays. As part of the service offered to animal owners, Animals R Us Limited collects and returns the pet animals at the beginning and end of the period of their stay. The companys mission statement is to provide very high value for money to all of our clients. The directors are now considering the creation of an Animal Sanctuary for homeless animals which would involve an allocation of 20% of the total accommodation available for homeless animals. The Animal Sanctuary would accommodate homeless animals until such time as a new owner was found for them. Animals R Us Limited would not receive any revenue whatsoever in respect of any homeless animal. Required: Critically discuss the purpose of mission statements as well as the potential benefits and potential problems of mission statements; (11 marks) Advise the directors of Animals R Us Limited regarding the appropriateness of its mission statement. (6 marks) Explain the term critical success factor and discuss THREE critical success factors for Animals R Us Limited clearly highlighting a key performance indicator for each critical success factor. (8 marks) Total (25 marks) QUESTION 3 Because of the central role of Research & Development (R&D) in Novotech Ltd.s strategy, the company has put considerable effort and funding into this area in recent years. There are a number of organisational R&D sub-units within the organisation, including some attached to individual production plants (which tend to emphasise product development and modification) and another at the companys headquarters (which has a more long-term research focus). John ONeill explains the approach to staffing and funding these R&D units in the following terms. First, the company endeavours to hire only highly qualified and motivated R&D engineers. Second, funding of each R&D unit is generous. As a minimum, each R&D unit is given a budget each year equal to its budget in the previous year plus an increment for inflation. Furthermore, an individual R&D unit can request additional funding for particular projects and a high proportion of these requests are granted so long as the likely technical success of the project can be demonstrated. In principle, an R&D unit could announce that it was discontinuing a major project and a proportion of its basic budget would be cut, but this never happens. A consultant has expressed the view to Nigel that a significant amount of current R&D expenditure may be wasteful and has suggested a new budgetary approach in order to reduce this problem. This would involve two steps. First, only 80% of each units previous years budget would be renewed automatically for the current year. Second, although R&D units would remain free to request additional funding for particular projects, the evaluation of these projects would become
much more rigorous. In particular, funding would only be considered where specific non-financial performance measures were specified in advance. During the life of each funded project, the progress of the project would be assessed continuously by reference to the agreed non-financial performance measures, with a view to discontinuing any project where the promised performance was not being achieved. Required: Explain fully, three significant ways in which the performance of R&D units might be improved if the consultants solution were implemented. (12 marks) John ONeill has asked the consultant to illustrate his idea of using non-financial performance measures to assess R&D projects while they are still ongoing. he has referred to the case of a new type of production technology which is currently being developed by an R&D unit. The purpose of this technology is to facilitate easier customisation of products in response to customer requests. The technology will not be ready for commercial application until 2012, but the R&D staff are testing and refining it under simulated conditions in a laboratory. Explain two non-financial performance measures which could be used to measure the performance of this R&D project at six-monthly intervals while it is still in the laboratory. (8 marks) Identify one example of R&D expenditure which is not amenable to the type of control suggested by the consultant, and suggest how (if at all) an organisation can exercise control over it. (5 marks) Total (25 marks) QUESTION 4 Hewlart Limited produces and sells one product only. The standard cost and selling price for one unit is as follows: Direct material 10 kilograms at 15 per kg 150 Direct wages 5 hours at 8 per hour 40 Variable cost 190 Selling price 300 The budgeted fixed production overhead cost is 45,000 and sales of 750 units were budgeted. Hewlart Limited uses a marginal costing system. During April 2020 the actual results were as follows: Sales 700 units @ 320 224,000 Direct materials: 7,500 kg 111,750 Direct wages 3,400 hours 27,880 Fixed production overhead 37,000 176,630 Profit 47,370 Note: Hewlart Limited does not hold any inventories. You are required to: Calculate the following variances for April 2020: Sales price;Sales volume;Material price;Material usage;Labour rate;Labour efficiency;Fixed overhead expenditure. (14 marks) Discuss two possible reasons for each of the material usage and labour rate variances calculated in part (a) above. (5 marks) Critically discuss two benefits and two limitations of a standard costing system. (6 marks) Total (25 marks) QUESTION 5 Heighway Co is a railway company. Heighway Co. 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 Co 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 Co for the last two years are given below. Summarised income statement for the year ended 31 December 2018 2019 $ million $ million Sales revenue 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 (balance sheet) as at 31 December 2018 2019 $m $m $m $m Non-current assets (net) 100.4 120.5 Current assets Inventory 5.3 5.9 Receivables 2.1 2.4 Cash 6.2 3.6 13.6 11.9 114.0 132.4 Ordinary share capital ($1 shares) 25.0 25.0 Reserves 45.6 48.2 Amounts payable after more than one year 8% Debenture 20X9 15.0 15.0 Bank loan 20.0 35.0 Payables due within one year 8.4 9.2 114.0 132.4 Required (a) Calculate the following ratios for Heighway Co for 2018 and 2019, clearly showing your workings. (i) Return on capital employed (also known as return on investment) based upon closing capital employed (ii) Net profit margin (iii) Asset turnover Current ratio (8 marks) (b) Briefly comment on the financial performance of Heighway Co in 2018 and 2019 as revealed by the above ratios and suggest causes for any changes. (6 marks) Suggest THREE non-financial indicators that could be useful in measuring the performance of a passenger railway company and explain why your chosen indicators are important. (4 marks) (d) Explain what is meant by short-termism and suggest ways in which a long-term view can be encouraged. (7 marks) (Total = 25 marks)