Performance Management

PART 3 FRIDAY 6 DECEMBER 2002

QUESTION PAPER Time allowed 3 hours This paper is divided into two sections Section A BOTH questions are compulsory and MUST be answered TWO questions ONLY to be answered

Section B

Paper 3.3

Section A BOTH questions are compulsory and MUST be attempted 1 Privmed is a privately owned profit seeking hospital that specialises in operations to replace hip and knee joints. Privmed traditionally determines its prices by adding a 10% mark-up to the budgeted full cost of an operation. The fixed overheads are absorbed on the basis of operating hours using a predetermined rate. Privmed Operating and Financial Data for 2001 Hip Total operating capacity (hours) Theatre utilisation ratio Average duration of operation 30 hours Number of operations taken * Total Costs Fixed overheads * not given The variable costs per operation are as budgeted. Privmed Budgeted Data for 2001 Hip Fixed overhead Annual operating hours Variable cost per operation * not given Required: (a) Calculate the number of hip operations undertaken during the year and the variable cost of performing a knee operation. (4 marks) (b) Calculate the prices that Privmed would have charged in 2001 for: (i) A hip operation; (4 marks) Knee Total 10,800 70%

36 hours 1270 15,036,780 12,000,000

Knee

Total 12,000,000 8,000

1,450

(ii) A knee operation.

(c) An activity based costing study recently discovered that the fixed overheads are determined by non operating time related activities. The study revealed the following data: Activity Consultations with potential patients X-rays Post-operative care Required: Re-calculate the prices that would have been charged in 2001 for each knee and hip operation by using an activity based costing approach. (5 marks) (d) Compare the results of your calculated prices in (b) and (c) and suggest with reasons what pricing decisions you would recommend to the hospital. (5 marks) (e) The Regional Public Health Authority is under pressure to reduce the length of its patients waiting lists for knee and hip operations. In an effort to improve the situation the area manager has approached Privmed and asked them to consider whether they would undertake some operations on a fee-paying basis. The approach is welcome, as the hospitals Theatre Manager would like to improve the utilisation of the facilities. Indeed, the hospital recently employed a consultant for a fee of 70,000 to assess the financial viability of undertaking public health authority operations at differing levels. The consultant concluded that contracting to undertake public health authority operations would also add to the administrative workload currently undertaken by the hospital e.g. billing and quality monitoring activities. It would be necessary to employ an additional clerk for 15,000 pa and additional variable administrative cost per operation would be 150 for a knee operation and 100 for a hip operation. If the hospital were to take on this work, it must also consider an additional requirement to keep 25% of its total operating capacity spare to meet the immediate needs of its special clients i.e. it cannot plan to use this proportion of its total capacity. 2 Cost Driver Number of consultations Number of X-rays Days of care Hip 3,000 6,200 7,860 Knee 2,000 6,200 23,580 Fixed 0verheads 8,980,000 1,800,000 1,220,000

The public health authority has approached the hospital and has proposed two alternative one-year contracts: Contract (1) The hospital would be required to perform an equal number of hip and knee operations during the next year that would utilise their remaining available spare capacity. The public health authority has agreed that the contract price should be composed of all the relevant incremental costs of the contract plus an 80% mark up. Contract (2) The hospital would be required to perform 1,500 knee operations. The public health authority will refund all the additional administrative costs resulting from the contract. The 1,500 additional knee operations would require the hospital to install a temporary operating theatre for a total cost of 500,000 with a two-year life. On completion of the contract, the hospital estimates that it could lease the temporary theatre during its second year with the following revenue estimates: 30% probability of earning 200,000 40% probability of earning 100,000 30% probability of earning 80,000 The public health authority is only prepared to pay 3,500,000 in addition to the refund of administrative costs for this one-year contract. Required: (i) Calculate the contract price and estimated financial benefit of Contract 1; (7 marks) (3 marks)

(ii) Calculate the estimated financial benefit of Contract 2. Note: The data/calculations in this section are at 2001 price levels. (f)

If either of the contracts were to be taken on, it would result in no capacity being available to meet an unexpected increase in demand from its private patients. Required: Explain the potential revenue consequences of such an event occurring and compile a list of information/data that you require to assess the financial consequences of the private patient demand unexpectedly rising to 80% of the total capacity during the contract year. (7 marks)

(g) Suggest three broad areas of non-financial performance that the public health authority is likely to have to monitor as part of a contract involving knee and hip operations. Your answer should include specific variables that are to be monitored. (5 marks) (40 marks)

[P.T.O.

Mack-King, a long established UK fast food chain expanded its operations abroad for the first time in 1999 in Coja. Although the UK business is much larger than the new operation in Coja, they both operate as semi-autonomous business divisions with their own performance targets. Compared with the UK, the Coja business environment is characterised by significant political uncertainty and limited general awareness of Mack-King products and outlet locations. Financial Data (000) for Mack-King 2000 ACTUALS 2001 ACTUALS COJA TOTAL UK COJA TOTAL 70 850 845 106 951 10 20 5 35 30 8 38 73 (3) 40 210 170 85 465 90 14 108 212 677 173 560 216 165 85 466 70 100 170 636 209 520 12 24 5 41 70 16 86 127 (21) 90 228 189 90 507 140 41 116 297 804 147 610

TURNOVER Less: Labour Materials Other Operating Costs

UK 780 200 150 80 430 60 100 160 590 190 520

Marketing Interest (Group) Depreciation and amortisation

Total Costs Profit NBV of Fixed Assets (year end) (includes capital expenditure in the year) Capital expenditure in year Long-Term Debt (Group) Capital and Reserve Required:

90

30

120 140 600

100

66

166 340 744

(a) Provide an assessment of the total corporate financial performance of Mack-King and of the contribution made towards it by each of the two divisions between 2000 and 2001. (8 marks) (b) Identify and explain the purpose of any additional information that would be required to provide a more complete assessment of Mack-Kings financial performance. (4 marks) (c) Explain the problems that may arise in endeavouring to assess the comparative financial performance of the management in the two divisions. Suggest any allowances/adjustments that could be made to improve the validity of any comparisons between managers operating in different countries. (4 marks) (d) Suggest two separate measures of performance that would be appropriate for a fast food chain, for each of the following areas: Service Quality; Marketing Effectiveness; Personnel; Food Preparation.

(4 marks) (20 marks)

Section B TWO questions ONLY to be attempted 3 You are responsible for managing the preparation of all revenue and cost budgets for a motor component manufacturer. You are aware that the external environment has a significant impact on the business activity and financial performance of your company and that the current information systems are underdeveloped and ineffective in this respect. Required: (a) Identify which aspects of the external environment you are likely to consider and give reasons for your choice. (10 marks) (b) Identify where you might find the relevant sources of information. (c) Suggest how an external environment information system could be introduced into your company. (5 marks) (20 marks) (5 marks)

(a) Explain the role and content of a Mission Statement.

(5 marks)

(b) Explain how a Mission Statement could contribute towards the planning and performance measurement process. (9 marks) (c) Identify the potential problems arising from using a Mission Statement to manage performance. (6 marks) (20 marks)

An essential aspect of financial and business planning is concerned with estimating costs and revenues and deciding the optimum output and price levels. A company produces a single product and operates in a market where it has to lower the sale price of all its units if it wishes to sell more. The companys costing and marketing departments currently use the following cost and revenue model (all output is sold in the current period): Current Model: Total Costs = 5,000 + 06x Total Revenue = 20x 001x2 Where x = the number of units sold The company has recently updated its cost and revenue model: Revised model: Total Costs = 4,750 + 08x Total Revenue = 19x 0009x2 The acceptability of the current model and the proposed changes as a basis for profit planning and for monitoring performance is to be reviewed. Required: (a) Explain the structure of the current and the revised model. (4 marks)

(b) It has been estimated that the revised model will result in an optimal output of 1,011 units being produced and sold. (i) Suggest two alternative ways of determining this optimal level of output. (3 marks)

(ii) Discuss the extent to which adherence to this output target is a satisfactory indicator of managerial performance. (3 marks) (c) Name and comment on cost and revenue factors which should be considered in order to improve the validity of the model as a profit forecasting model. (10 marks) (20 marks) End of Question Paper 5