Advanced Performance Management (APM) Flashcards

A company uses Economic Value Added (EVA) to measure divisional performance. Division A has a net operating profit after tax (NOPAT) of £2.5 million and capital employed of £15 million. The company's WACC is 12%. What is Division A's EVA?

Answer: £0.7 million

EVA = NOPAT - (Capital employed × WACC) = £2.5m - (£15m × 12%) = £2.5m - £1.8m = £0.7m. A positive EVA of £0.7 million indicates Division A is generating returns above the minimum required by investors, creating genuine economic value. If EVA were negative, the division would be destroying shareholder value despite reporting an accounting profit.

In the context of transfer pricing, which of the following methods is MOST likely to lead to sub-optimal decision-making from the group's perspective?

Answer: Full cost-plus transfer price when there is no external market

Full cost-plus transfer pricing is most likely to lead to sub-optimal group decisions because it includes an element of fixed cost (which is a sunk cost for group decision-making) plus an arbitrary mark-up. This inflates the cost to the receiving division, potentially leading it to reject transactions that would be profitable for the group. Market-based prices are generally optimal when markets exist, and marginal cost reflects true incremental cost.

A hospital uses the building block model (Fitzgerald and Moon) to measure performance. Which of the following dimensions measures service outcomes rather than processes?

Answer: Competitiveness

The Fitzgerald and Moon building block model identifies six performance dimensions split into two categories: results (competitiveness, financial performance) and determinants (quality, flexibility, resource utilisation, innovation). Competitiveness measures outcomes such as market share, sales growth, and customer retention — it reflects the results of the organisation's efforts rather than the processes used to achieve them.

Which of the following BEST describes the concept of 'beyond budgeting'?

Answer: Replacing fixed annual budgets with adaptive management processes using rolling forecasts and relative targets

Beyond budgeting is a management philosophy that replaces traditional fixed annual budgets with more adaptive and decentralised management processes. It uses rolling forecasts, relative performance targets (e.g., beating competitors rather than fixed numbers), decentralised decision-making, and resources made available on demand. Key proponents include the Beyond Budgeting Round Table (BBRT).

A manufacturing company discovers that 80% of its quality costs are 'failure costs' (internal and external). According to the total quality management (TQM) approach, the company should:

Answer: Increase spending on prevention and appraisal to reduce total quality costs

TQM theory suggests that investing more in prevention costs (training, process improvement, supplier quality management) and appraisal costs (inspection, testing) will significantly reduce the much larger failure costs (scrap, rework, warranty claims, lost customers). The optimal quality cost profile has higher prevention spending and minimal failure costs, resulting in lower total quality costs overall.

A company evaluates its managers using Return on Investment (ROI). A division manager rejects a project with a 15% return because the division's current ROI is 20%. The company's cost of capital is 10%. This demonstrates which weakness of ROI?

Answer: ROI encourages dysfunctional behaviour by incentivising managers to reject projects that exceed the cost of capital but reduce divisional ROI

This is the classic dysfunctional behaviour problem with ROI. The project returns 15%, which exceeds the 10% cost of capital and would create value for the company. However, the manager rejects it because accepting a 15% return would dilute the division's current 20% ROI. This goal incongruence means managers act in their own interest rather than the company's. Residual income (RI) or EVA resolves this problem.