Tutorial Set 5
Performance Management
Question 1
Irene Inc. operates two divisions, a Lorry Rental Division that rents to individuals and a
Transportation Division that transports goods from one city to another. Results reported for the
last year are as follows:
Lorry Rental Transportation
Division Division
GHS GHS
Total assets 650,000 950,000
Current liabilities 120,000 200,000
Operating profit before tax 75,000 160,000
Required:
a. Calculate the return on investment for each division, where investment equal to total assets
minus current liabilities.
b. Calculate the residual income for each division, where investment equal to total assets minus
current liabilities. The required rate of return on investments is 12%.
c. The company has two sources of funds: long-term debt with a market value of GHS 900,000 at
an interest rate of 10% and equity capital with a market value of GHS 600 000 at a cost of equity
of 15%. Irene Inc.’s income tax rate is 40%. Irene Inc. applies the same weighted-average cost
of capital to both divisions, since each division faces similar risks. Calculate the economic value
added (EVA®) for each division.
d. Using your answers to requirements b and c, what would you conclude about the performance
of each division? Explain briefly.
Question 2
William K. Ltd has three operating divisions. The managers of these divisions are evaluated on
their divisional operating profit, a figure that includes an allocation of corporate overhead
proportional to the revenues of each division. The operating profit statement for the first quarter
of 2025 is as follows:
Tempere Oulu Kotka Total
Division Division Division
GHS’000 GHS’000 GHS’000 GHS’000
Revenues 2,000 1,200 1,600 4,800
Cost of goods sold 1,050 540 640 2,230
Gross profit 950 660 960 2570
Division overhead 250 125 160 535
Corporate overhead 400 240 320 960
Divisional operating profit 300 295 480 1,075
The manager of the Tampere Division is unhappy that his profitability is about the same as the
Oulu Division's and is much less than the Kotka Division's, even though his revenues are much
higher than either of these other two divisions'. The manager knows that he is carrying one line
of products with very low profitability. He was going to replace this line of business as soon as
more profitable product opportunities became available, but he has kept it because the line is
marginally profitable and uses facilities that would otherwise be idle. That manager now realises,
however, that the sales from this product line are attracting a fair amount of corporate overhead
because of the allocation procedure and maybe the line is already unprofitable for him. This low-
margin line of products had the following characteristics for the most recent quarter (in GHS’000):
Revenues 800
Cost of goods sold 600
Avoidable division overhead 100
Required:
a. Prepare the operating profit statement for William K. Ltd for the second quarter of 2005.
Assume that revenues and operating results are identical to the first quarter except that the
manager of the Tampere Division has dropped the low-margin product line from his product
group.
b. Is William K. Ltd better off from this action?
c. Is the Tampere Division manager better off from this action?
d. Suggest changes for Mikkeli's system of division reporting and evaluation that will motivate
division managers to make decisions that are in the best interest of William K. Ltd as a whole.
Discuss any potential disadvantages of your proposal.
Question 3
The traditional method of performance management had been critized to have focused heavily
on financial performance to the neglect of key value-adding metrics. In recent years, organizations
are deploying the balanced scorecard to address the shortcomings of the traditional performance
management systems.
Required:
a. What is the balanced scorecard?
b. Describe the four perspectives of the balanced scorecard showing how it aligns with
organizational strategy.
c. Evaluate the benefits and difficulties of deploying the balance scorecard.