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  • 15 Marks

PM – May 2024 – L2 – SC – Q5 – Divisional Performance Measurement

Calculation of transfer prices and performance appraisal in a holding company.

Zona Tango (ZT) plc is a holding company with four divisions, including Alba and Beta Divisions. Alba Division produces a component that it sells externally, and can also transfer to other divisions within the group.

Beta Division uses the components from Alba Division as a raw material for its final product. The division can also obtain the components from external suppliers. The components, when obtained from Alba Division, undergo further processing at a cost of ₦4.50 per unit before they are sold to the external market.

The Board of Directors, in order to implement a new Appraisal Review, has set up a performance scheme for the divisional managers. A performance target for the next financial year has been set, and the following budgeted information relating to the two divisions has been prepared:

Beta Division has asked Alba Division to quote a transfer price for units of the components.

Required:
a. Calculate the transfer price per unit which Alba Division should quote to Beta Division in order that its budgeted residual income target will be achieved. (3 Marks)
b. Calculate the selling price per unit which Beta Division should quote to the external market in order that its budgeted residual income target will be achieved, based on the transfer price quotation. State clearly your assumptions. (3 Marks)
c. Explain why the transfer price calculated in (a) may lead to sub-optimal decision-making from the point of view of ZT plc, taken as a whole. (5 Marks)
d. In what circumstances will a negotiated transfer price be used instead of a market-based price? (4 Marks)

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  • 20 Marks

PM – May 2019 – L2 – Q2 – Divisional Performance Measurement

Discuss the benefits of EVA and calculate it for Tees Nigeria Ltd based on provided financial data.

Peter Drucker opined that “until a business returns a profit that is greater than its cost of capital, it operates at a loss.” Therefore, experts have challenged accounting profit as a good measure of business value increase and proposed economic value added (EVA) as a better measure.

Tees Nigeria Limited has presented the following financial data for the year ended 31 December 2018:

Income Statement 2018:

Item ₦000
Profit before interest and tax 75,000
Interest cost (9,000)
Profit before tax 66,000
Tax at 30% (19,800)
Profit after tax 46,200
Dividends paid (30,000)
Retained profit 16,200

Statement of Financial Position 2018:

Item ₦000
Non-current assets 305,000
Net current assets 190,000
Total assets 495,000
Shareholders’ funds 395,000
Long-term debt 100,000
Capital employed 495,000

Notes:
(i) Capital employed at the beginning of the year was ₦420 million.
(ii) The company had non-capitalised leased assets of ₦24 million.
(iii) The estimated cost of equity was 10%, and the cost of debt was 7%.
(iv) The company’s target capital structure is 60% equity and 40% debt.
(v) Other non-cash expenses were ₦16 million.
(vi) Depreciation is equal to economic depreciation.

Required:
a. Discuss the perceived benefits of using EVA to measure business performance. (10 Marks)
b. Calculate the real economic profit of Tees Nigeria Limited using EVA. (10 Marks)

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  • 20 Marks

AFM – Nov 2018 – L3 – Q4 – Financial reconstruction

Explain the concept of EVA, calculate EVA and NOPAT for 2016 and 2017, and distinguish between spin-offs and sell-offs.

Jabesh Company limited income statements for the years 2016 and 2017 are provided below:

The company directors at a meeting argued that the use of Economic Value Added as a measure of corporate performance is more relevant to current developments in financial markets and agreed to employ it in assessing its performance for years 2017 and 2016.

Additional information is as follows:

  1. The allowance for doubtful debts was GH¢300,000 at 1 January 2016, GH¢250,000 at 31 December 2016, and GH¢350,000 at 31 December 2017.
  2. Research and development costs of GH¢500,000 were incurred during each of the years 2016 and 2017 on Project Z. These costs were expensed in the income statement, as they did not meet the requirements of financial reporting standards for capitalization. Project Z is not complete yet.
  3. At the end of 2015, the company had completed another research and development project, Project X. Total expenditure on this project had been GH¢1,500,000, none of which had been capitalized in the financial statements. The product developed by Project X went on sale on 1 January 2016, and the product was a great success. The product’s lifecycle was only two years, so no further sales of the product are expected after 31 December 2017.
  4. The company incurred non-cash expenses of GH¢15,000 in both years.
  5. Capital employed (equity plus debt) per the statement of financial position was GH¢33,500 at 1 January 2016 and GH¢37,000 at 1 January 2017.
  6. The pre-tax cost of debt was 5% in each year. The estimated cost of equity was 12% in 2016 and 14% in 2017. The rate of corporate tax was 25% during both years.
  7. The company’s capital structure was 60% equity and 40% debt.
  8. There was no provision for deferred tax.

Required:
a) Explain what the directors meant by Economic Value Added (EVA). (2 marks)

b) Calculate the company’s Economic Value Added (EVA) for the years ended 2017 and 2016. (5 marks)

c) Calculate the Net Operating Profit After Tax (NOPAT) for the years ended 2017 and 2016. (6 marks)

d) Explain spin-offs and sell-offs, and identify THREE (3) reasons for spin-offs. (7 marks)

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  • 15 Marks

PM – May 2024 – L2 – SC – Q5 – Divisional Performance Measurement

Calculation of transfer prices and performance appraisal in a holding company.

Zona Tango (ZT) plc is a holding company with four divisions, including Alba and Beta Divisions. Alba Division produces a component that it sells externally, and can also transfer to other divisions within the group.

Beta Division uses the components from Alba Division as a raw material for its final product. The division can also obtain the components from external suppliers. The components, when obtained from Alba Division, undergo further processing at a cost of ₦4.50 per unit before they are sold to the external market.

The Board of Directors, in order to implement a new Appraisal Review, has set up a performance scheme for the divisional managers. A performance target for the next financial year has been set, and the following budgeted information relating to the two divisions has been prepared:

Beta Division has asked Alba Division to quote a transfer price for units of the components.

Required:
a. Calculate the transfer price per unit which Alba Division should quote to Beta Division in order that its budgeted residual income target will be achieved. (3 Marks)
b. Calculate the selling price per unit which Beta Division should quote to the external market in order that its budgeted residual income target will be achieved, based on the transfer price quotation. State clearly your assumptions. (3 Marks)
c. Explain why the transfer price calculated in (a) may lead to sub-optimal decision-making from the point of view of ZT plc, taken as a whole. (5 Marks)
d. In what circumstances will a negotiated transfer price be used instead of a market-based price? (4 Marks)

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  • 20 Marks

PM – May 2019 – L2 – Q2 – Divisional Performance Measurement

Discuss the benefits of EVA and calculate it for Tees Nigeria Ltd based on provided financial data.

Peter Drucker opined that “until a business returns a profit that is greater than its cost of capital, it operates at a loss.” Therefore, experts have challenged accounting profit as a good measure of business value increase and proposed economic value added (EVA) as a better measure.

Tees Nigeria Limited has presented the following financial data for the year ended 31 December 2018:

Income Statement 2018:

Item ₦000
Profit before interest and tax 75,000
Interest cost (9,000)
Profit before tax 66,000
Tax at 30% (19,800)
Profit after tax 46,200
Dividends paid (30,000)
Retained profit 16,200

Statement of Financial Position 2018:

Item ₦000
Non-current assets 305,000
Net current assets 190,000
Total assets 495,000
Shareholders’ funds 395,000
Long-term debt 100,000
Capital employed 495,000

Notes:
(i) Capital employed at the beginning of the year was ₦420 million.
(ii) The company had non-capitalised leased assets of ₦24 million.
(iii) The estimated cost of equity was 10%, and the cost of debt was 7%.
(iv) The company’s target capital structure is 60% equity and 40% debt.
(v) Other non-cash expenses were ₦16 million.
(vi) Depreciation is equal to economic depreciation.

Required:
a. Discuss the perceived benefits of using EVA to measure business performance. (10 Marks)
b. Calculate the real economic profit of Tees Nigeria Limited using EVA. (10 Marks)

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  • 20 Marks

AFM – Nov 2018 – L3 – Q4 – Financial reconstruction

Explain the concept of EVA, calculate EVA and NOPAT for 2016 and 2017, and distinguish between spin-offs and sell-offs.

Jabesh Company limited income statements for the years 2016 and 2017 are provided below:

The company directors at a meeting argued that the use of Economic Value Added as a measure of corporate performance is more relevant to current developments in financial markets and agreed to employ it in assessing its performance for years 2017 and 2016.

Additional information is as follows:

  1. The allowance for doubtful debts was GH¢300,000 at 1 January 2016, GH¢250,000 at 31 December 2016, and GH¢350,000 at 31 December 2017.
  2. Research and development costs of GH¢500,000 were incurred during each of the years 2016 and 2017 on Project Z. These costs were expensed in the income statement, as they did not meet the requirements of financial reporting standards for capitalization. Project Z is not complete yet.
  3. At the end of 2015, the company had completed another research and development project, Project X. Total expenditure on this project had been GH¢1,500,000, none of which had been capitalized in the financial statements. The product developed by Project X went on sale on 1 January 2016, and the product was a great success. The product’s lifecycle was only two years, so no further sales of the product are expected after 31 December 2017.
  4. The company incurred non-cash expenses of GH¢15,000 in both years.
  5. Capital employed (equity plus debt) per the statement of financial position was GH¢33,500 at 1 January 2016 and GH¢37,000 at 1 January 2017.
  6. The pre-tax cost of debt was 5% in each year. The estimated cost of equity was 12% in 2016 and 14% in 2017. The rate of corporate tax was 25% during both years.
  7. The company’s capital structure was 60% equity and 40% debt.
  8. There was no provision for deferred tax.

Required:
a) Explain what the directors meant by Economic Value Added (EVA). (2 marks)

b) Calculate the company’s Economic Value Added (EVA) for the years ended 2017 and 2016. (5 marks)

c) Calculate the Net Operating Profit After Tax (NOPAT) for the years ended 2017 and 2016. (6 marks)

d) Explain spin-offs and sell-offs, and identify THREE (3) reasons for spin-offs. (7 marks)

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