PE01 (35 MARKS: 42 MINUTES)

1Logics Ltd is a JSE listed company, in the logistics sector. 1Logics hired a new CEO at the
beginning of the 2015 financial year. Currently management performance is based on Return on Commented [CDJ1]: As a new CEO have to deal with anything
that was done wrong in the past, so in the first year often hard to have
Investment. Extracts of the financial statements have been provided below in R 000s: good performance. Also change takes time and generally money up
front.
Summarised consolidated statement of comprehensive income
31-May 31-May
Note 2015 2014
Revenue 1 367 980 1 272 071
Operating and administration costs 2 -1 168 074 -1 101 240
Depreciation and amortisation -79 265 -61 792
Share-based payment specific share issue for cash -71 621
(Loss)/profit on sale of assets -366 9 572
Profit from disposal of discountinued operations 145 995 10 218
Profit before interest, tax and other group income 194 649 128 829
Share of profits from associate 9 834 5 520
Finance costs -29 661 -21 442
Profit before taxation 174 822 112 907
Taxation -26 772 -26 451
Profit for the year 148 050 86 456
Statement of Financial position 31-May 31-May
ASSETS 2015 2014
Non-current assets 1 035 775 665 288
Property, plant and equipment 849 947 532 672
Intangible assets 132 184 77 257
Investment in associate 43 964 38 125
Loans and receivables 8 148 15 033
Deferred taxation 1 532 2 201
Current assets 393 061 260 935
Inventories 22 222 10 376
Trade and other receivables 210 422 179 455
Taxation 781
Cash resources 160 417 70 323
Non-current assets held-for-sale 20 082
Total assets 1 448 918 926 223

EQUITY AND LIABILITIES

Equity 688 418 371 577
Ordinary shareholders funds 643 988 334 978
Non-controlling interests 44 430 36 599
Liabilities
Non-current liabilities 419 476 234 812
Interest-bearing borrowings 313 592 168 165
Deferred tax 105 884 66 647
Current liabilities 341 024 319 834
Trade and other payables 187 116 182 939
Interest-bearing borrowings 146 369 90 134
Vendor liability 9 000
Taxation 6 592 1 371
Bank overdraft 947 36 390
Total equity and liabilities 1 448 918 926 223
 R135 million PostWeb
Phase 1 of Logistics disposal
Hub (KZN) complete.
complete
Note 2: Operating and administrative expenses
-1 168 074 -1 101 240
Fuel and motor vehicle expenses -319 586 -379 969
Other operating expenses -382 094 -369 385
Staff training -32 781 -6 231
Employment costs -433 613 -345 655

Note 3: Disposal of PostWeb

In the year we disposed of our full shareholding in PostWeb to Bramex (US) Ltd for a consideraion
of R190.6 million. Proceeds net of cash balances disposed of and capital gains tax amounted to
R148.6 million. Profit after tax on the disposal amounted to R144,2 million.
The sale was deemed to be in the best interest of both the group and Postweb in light of the skills
required to further optimise the franchise organisation, which fall outside of our now more evolved
core competencies.
Note 4: Logistics Hub
As part of the growth phase 1Logics is currently experiencing an investment was made towards
building a new hub. This is a centre or specific area designated to deal with activities related to
transportation, organisation, separation, coordination and distribution of goods for national and
international transit. Phase 1 investment occurred evenly between January 2015 and April 2015
when it was completed, and the hub is expected to be fully operational in the first quarter of the 2016
financial year. A further R50m was spent on phase two during May 2015.
New CEOs comment:
With a 78% increase in EPS it has been another successful and profitable year. Not only have we
had a significant growth in profits but we have also grown revenue at a rate higher than inflation.
We feel assessing performance based on ROI is not correct as this does not align our interest with
that of investors. We recommend using EPS* as a measure of performance, as this reflects the
actual return to shareholders.
Commented [CDJ2]: This caused the huge increase in EPS
(whereas when removed you see the HEPS is much lower). If you are
using net profit as a performance measure there has been a huge
increase in profit, but it is not sustainable or from good operating
performance. This is management potentially trying to make results
look better.
Commented [LT3]: Generally sticking to core business is a good
strategy, however selling off of items should not be taken into
account when assessing performance as it is not sustainable, and does
not encourage growth. So strategically sound, but doesnt work out
from a performance evaluation perspective.
Commented [LT4]: What this is suggesting is there was a large
investment in PPE near the end of the 2015 year, however the
benefits would only be received in the future as the investment is not
fully operational.
So if you use closing balance you are including this investment even
though it is not generating income. This disadvantages management.
Commented [LT5]: Why would ROI not be a good performance
measure? What has management done that would reduce ROI? Are
the things they did good or bad for ROI?

*EPS is calculated as Net profit after tax / number of shares

Investor comment:
ROI is a measure of how well management have utilised the assets given to them at the beginning
of the year. When making an investment we as investors had a required return of 15% (WACC),
thus to measure managements performance we should first and foremost ensure they achieved a
return greater than 15%. EPS does not take into account the amount invested and thus is not a good Commented [LT6]: Comment is true, but what is not taken into
account in ROI? (hint: think asset side).
measure.

Other industry considerations:

During the year there were labour strikes which resulted in a large salary increase for the majority of Commented [LT7]: Why are they telling you this? Always think
about controllability.
staff. Fortunately, this negotiation did not disrupt revenue as the company managed to source
temporary staff to fill the gap. This, however, resulted in a higher staff cost for the year. Staff
training was done for all staff, during the first week of the financial year, in order to educate staff on Commented [LT8]: Is staff training a good thing? How does it
affect your different performance measures? When does the company
the company goals and the changes that were put in place. It is expected that this would increase get the benefits from this?
productivity for the next 3 years. The reduction in the fuel price resulted in a large benefit for the Commented [LT9]: Is this controllable?
company due to the majority of logistics being vehicle based. In general, due to a slowdown in the
South African economy, the majority of logistics companies have only achieved revenue growth of
1%-2%, and a decrease in net profits of 2-3%.

Marks
REQUIRED Sub-
Total
total
(a) Discuss whether you agree with the comment made by the
investor, and what the negative consequences are of using ROI as
a performance measure? 5 5
(b) Comment of managements performance during the 2015 year.
Your answer should include the following:

i. A calculation of ROI for the 2015 and 2014 financial year- 6

ends.
ii. A consideration of whether ROI has been manipulated by 4
the new CEO or not?
3
iii. A discussion on the CEOs comment on EPS and whether
it would be an accurate reflection of managements
performance.
iv. A discussion of any other factors which should be 8 Commented [LT10]: This type of questions is leading you to
think about other qualitative considerations as well as discussing any
considered when assessing managements performance for controllable or non-controllable items that may have effected
2015? Clearly state how these factors would have affected 23 performance.

ROI for 2015?

Layout and communication 2
(c) Calculate EVA for the 2015 year and briefly discuss what this 7 7
indicates about managements performance.

TOTAL 35
PE01 Solution
a. I agree ROI is meant to be a measure of asset utilisation, and this should be measured against WACC. The Commented [LT11]: For ROI you could have done either of the
major issues with ROI are that: answers below and received full marks.
It is based on accounting numbers which are open to manipulation
With the short-term borrowing refer to Q&A as to why there was a
Growth is not encouraged
bonus for excluding.
Management might make the incorrect investment decisions.
Does not consider the risk of the business
Encourages management to focus short term
Total max 5
2015 2014
b(i) ROI Profit before interest after tax 147 228 =(174822+29661)*0.72 96 731 =(112907+21442)*0.72
Net investment 1 254 263 =(1448918-341024+146369) 696 523 =926223-319834+90134
Students could also take equity plus non-current liabilities plus short-term borrowings for the denominator.
ROI 11.74% =147228/1254263 13.89%
ALTERNATIVE
2015 2014
ROI Profit before interest after tax 169 406 =148050+(29661*0.72) 101 894 =86456+(21442*0.72)
Net investment 1 254 263 =(1448918-341024+146369) 696 523 =926223-319834+90134

ROI 13.51% =147228/1254263 14.63%

b(ii) If the CEO were trying to increase ROI they could have done the following: Commented [LT12]: EPS is basically profit divided by number
of shares. So you needed to think of the weaknesses of using net
not built the new hub in KZN. profit as a performance measure.
Not done staff training Instead management increased staff training costs.
In the real world there are not just 4 performance measures there are
Tried to get more funding through current liabilities, either in the overdraft of trade 100s but you always need to follow the same principles of assessing,
payables, greater than the increase in sales. Increases seem to be reasonable. what management will do (how they behave) and whether that is
what the firm wants (does it maximise shareholder wealth).
Leased assets instead of buying. Invested in new assets, so was not trying to
Commented [LT13]: With discussion questions you need to give
manipulate assets. a detailed enough answer. In this case management had not tried to
Sell more assets at a profit. This did happened, although the information tells us it was manipulate ROI, and you could explain what they did that reduced
ROI but was good for the company OR argue that what would have
strategic. needed to be done to increase ROI was not done.
Manager has chosen to pay back the bank overdraft, instead of using it as short term finance.
What are we testing? We are testing if you know how management
As he has not done these things so it would appear that he has not tried to manipulate ROI. behave to manipulate ROI, and whether you can pick up what actions
management have made and their effect on ROI.
Alternative:
The student could alternatively debate the other view:
There has been continued investment in fixed assets, thus no attempt to decrease net
investment. Management has increase staff training costs, which would not be the case if they
were trying to manipulate earnings. Management has also not tried to reduce net investment
by leasing assets. Funding through current liabilities has also increased however the majority
of additional funding was from non-current liabilities thus does not seem like manipulation.
The only possible attempt to increase ROI could be the sale of PostWeb , however this appears
to be a strategic move not manipulation.

b(iii) EPS is the same as using net profit as a performance measure. Yes one of the goals is to
increase net profit. However Net profit bottom line includes uncontrollable items. Also
net profit is historic, based on accounting numbers so open to manipulation and includes
once off non-recurring items. So yes it does address one aspect of performance but not
not address all the goals of investors. Management could increase EPS by doing share-buy
b(iv) When assessing managements performance we are generally looking at operating performance and of
that sustainable profits.
We should thus exclude the profit from sale of operations as this is a once off item which would have
been approved by shareholders. This would decrease ROI.
The oil price decreased substantially during the year, having a positive effect on profits, this was
outside of the control of management, and thus should not be included in assessing managements
There was a large increase in training costs, this is beneficial to the company but would have
decreased ROI. It is unfair to penalise management for incurring this expenditure as it is beneficial to the
Strikes were outside of the control of management, and this has led to a substantial increase in costs,
which decreased ROI. This increase needs to be taken out when comparing current year to prior year.
Management invested heavily in PPE near the end of 2015 year, which is included in net assets,
however the benefit of these assets will only be realised in future periods, so it is unfair to include the net
assets in the current years ROI calculation as it brings down the ROI.
Could use a Balanced scorecard or other mixes of performance measures as this takes into account
qualitative and quantitative factors.
2 marks for communication and layout (full sentences and easy to follow)

c Commented [CDJ14]: With discretionary costs need to also look

EVA Operating income 147 228 From aboveat past years to see what costs were capitalised and what costs need to
be amortised in the current year. In the past if discretionary costs
Add: Depreciation 79 265 were added to net investment you need to remember to amortise them
Subtract profit for sale (once off not operating) -145 995 (1) bonus in the current year.
Add loss of sale 366 (1 bonus) Commented [LT15]: Please note in this calculation depreciation
Add share based payment expense (non operating once off) 71 761 (1 bonus) has been added back. In the past we taught that you add back non-
cash items when I looked and this and discussed it with Carlos
Add back discretionary costs 32 781 Correia, we established you should not add back non-cash items.
If they include amortisation from prior year discretionary -2 077
Amortisation of discretionary costs -10 927 (32781/3)
Adjusted operating income 172 402

Opening Net investment 696 523 From above

Add discretionary costs less amortisation 21 854 (32781-10927)
Add remaining discretionary costs from prior year 2 077

Adjusted net investment 720 454

EVA = 172402- 15% x 720454 64 333.66

A positive NPV implies the division has done well in creating value from operations.