Paper 3.

3
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

Section B TWO questions ONLY to be answered

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 Knee Total
Total operating capacity (hours) 10,800
Theatre utilisation ratio 70%
Average duration of operation 3·0 hours 3·6 hours
Number of operations taken * 1270
Total Costs £15,036,780
Fixed overheads £12,000,000
* not given
The variable costs per operation are as budgeted.

Privmed Budgeted Data for 2001

Hip Knee Total
Fixed overhead £12,000,000
Annual operating hours 8,000
Variable cost per operation £1,450 *
* 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;
(ii) A knee operation. (4 marks)
(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 Cost Driver Hip Knee Fixed 0verheads
Consultations with potential patients Number of consultations 3,000 2,000 £8,980,000
X-rays Number of X-rays 6,200 6,200 £1,800,000
Post-operative care Days of care 7,860 23,580 £1,220,000
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 hospital’s 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 2·5%
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
 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)
(ii) Calculate the estimated financial benefit of Contract 2. (3 marks)
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)

3 [P.T.O.
2 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
UK COJA TOTAL UK COJA TOTAL
TURNOVER 780 70 850 845 106 951
Less:
Labour 200 10 210 216 12 228
Materials 150 20 170 165 24 189
Other Operating Costs 80 5 85 85 5 90
–––– ––– –––– –––– ––– ––––
430 35 465 466 41 507
–––– ––– –––– –––– ––– ––––
Marketing 60 30 90 70 70 140
Interest (Group) – – 14 – – 41
Depreciation and amortisation 100 8 108 100 16 116
–––– ––– –––– –––– ––– ––––
160 38 212 170 86 297
–––– ––– –––– –––– ––– ––––
Total Costs 590 73 677 636 127 804
Profit 190 (3) 173 209 (21) 147

NBV of Fixed Assets (year end) 520 40 560 520 90 610

(includes capital expenditure
in the year)
Capital expenditure in year 90 30 120 100 66 166
Long-Term Debt (Group) – – 140 – – 340
Capital and Reserve 600 744
Required:
(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-King’s 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)

4
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. (5 marks)
(c) Suggest how an external environment information system could be introduced into your company.
(5 marks)
(20 marks)

4 (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)

5 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 company’s 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 + 0·6x
Total Revenue = 20x – 0·01x2
Where x = the number of units sold
The company has recently updated its cost and revenue model:
Revised model:
Total Costs = 4,750 + 0·8x
Total Revenue = 19x – 0·009x2
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