Performance Management MCQ Quiz - Objective Question with Answer for Performance Management - Download Free PDF
Last updated on May 27, 2025
Latest Performance Management MCQ Objective Questions
Performance Management Question 1:
Tim International Park (TIP) is a theme park and has for many years been a successful business, which has traded profitably. About three years ago the directors decided to capitalise on their success and reduced the expenditure made on new thrill rides, reduced routine maintenance where possible (deciding instead to repair equipment when it broke down) and made a commitment to regularly increase admission prices. Once an admission price is paid customers can use any of the facilities and rides for free.
These steps increased profits considerably, enabling good dividends to be paid to the owners and bonuses to the directors. The last two years of financial results are shown below.
|
20X4 |
20X5 |
|
|
$ |
$ |
|
|
Sales |
5,250,000 |
5,320,000 |
|
Less expenses: |
||
|
Wages |
2,500,000 |
2,200,000 |
|
Maintenance - routine |
80,000 |
70,000 |
|
Repairs |
260,000 |
320,000 |
|
Directors' salaries |
150,000 |
160,000 |
|
Directors' bonuses |
15,000 |
18,000 |
|
Other costs (including depreciation) |
1,200,000 |
1,180,000 |
|
Net profit |
1,045,000 |
1,372,000 |
|
Book value of assets at start of year |
13,000,000 |
12,000,000 |
|
Dividend paid |
500,000 |
650,000 |
|
Number of visitors |
150,000 |
140,000 |
TIP operates in a country where the average rate of inflation is around 1% per annum.
(a) Assess the financial performance of TIP using the information given above.
(14 marks)
During the early part of 20X4 TIP employed a newly qualified management accountant. He quickly became concerned about the potential performance of TIP and to investigate his concerns, he started to gather data to measure some non-financial measures of success. The data he has gathered is shown below:
|
Table 1 |
||
|
20X4 |
20X5 |
|
|
Hours lost due to breakdown of rides (Note 1) |
9,000 hours |
32,000 hours |
|
Average waiting time per ride |
20 minutes |
30 minutes |
Note 1:
TIP has 50 rides of different types. It is open 360 days of the year for ten hours each day.
(b) Assess the QUALITY of the service which TIP provides to its customers using Table 1 and any other relevant data and indicate the RISKS it is likely to face if it continues with its current policies.
(6 marks)
(20 marks)
Answer (Detailed Solution Below)
Performance Management Question 1 Detailed Solution
(a) TIP's financial performance can be assessed in a number of ways:
Sales growth
Sales are up about 1·3% (W1) which is a little above the rate of inflation and therefore a move in the right direction. However, with average admission prices
jumping about 8-6% (W2) and numbers of visitors falling, there are clearly problems. Large increases in admission prices reduce the value proposition for the customer, it is unlikely that the rate of increase is sustainable or even justifiable. Indeed with volumes falling (down by 6·7% (W6)), it appears that some customers are being put off and price could be one of the reasons.
Maintenance and repairs
There appears to be a continuing drift away from routine maintenance with management preferring to repair equipment as required. This does not appear to be
saving any money as the combined cost of maintenance and repair is higher in 20X5 than in 20X4 (possible risks are dealt with in part (b)).
Directors' pay
Absolute salary levels are up 6·7% (W3), well above the modest inflation rate. It appears that the shareholders are happy with the financial performance of the
business and are prepared to reward the directors accordingly. Bonus levels are also well up. It may be that the directors have some form of profit related pay scheme and
are being rewarded for the improved profit performance. The directors are likely to be very pleased with the increases to pay.
Wages
Wages are down by 12% (W5). This may partly reflect the loss of customers (down by 6·7% (W6)) if it is assumed that at least part of the wages cost is variable. It could
also be that the directors are reducing staff levels beyond the fall in the level of customers to enhance short-term profit and personal bonus. Customer service and
indeed safety could be compromised here.
Net profit
Net profit is up a huge 31·3% (W7) and most shareholders would be pleased with that. Net profit is a very traditional measure of performance and most would say this
was a sign of good performance.
Return on assets
The profitability can be measured relative to the asset base which is being used to generate it. This is sometimes referred to as ROI or return on investment. The return
on assets is up considerably to 11·4% from 8% (W8). This is partly due to the significant rise in profit and partly due to the fall in asset value. We are told that TIP
has cut back on new development, so the fall in asset value is probably due todepreciation being charged with little being spent during the year on assets. In this
regard it is inevitable that return on assets is up but it is more questionable whether this is a good performance. A theme park (and thrill rides in particular) must be
updated to keep customers coming back. The directors of TIP are risking the future of the park.
Workings:
- (W1) Sales growth is $5,320,000/$5,250,000 = 1-01333 or 1-3%.
- (W2) Average admission prices were:
- 20X4: $5,250,000/150,000 = $35 per person
- 20X5: $5,320,000/140,000 = $38 per person
- An increase of $38/$35 = 1-0857 or 8-57%
- (W3) Directors' pay up by $160,000/$150,000 = 1-0667 or 6·7%.
- (W4) Directors' bonuses levels up from $15,000/$150,000 or 10%
- $18,000/$160,000 or 12:5% of turnover. This is an increase of 3/15 or 20%.
- (W5) Wages are down by (1 – $2,200,000/$2,500,000) or 12%.
- (W6) Loss of customers is (1 – 140,000/150,000) or 6·7%.
- (W7) Profits up by $1,372,000/$1,045,000 = 1·3129 or 31-3%.
- (W8) Return on assets:
- 20X4: $1,045,000/$13,000,000 = 1-0803 or 8-03%
- 20X5: $1,372,000/$12,000,000 = 1-114 or 11-4%
(b) Quality provision
Reliability of the rides
The hours lost has increased significantly. Equally the percentage of capacity lost due to breakdowns is now approaching 17·8% (W9). This would appear to be a very
high number of hours lost. This would surely increase the risk that customers are disappointed being unable to ride. Given the fixed admission price system, this is
bound to irritate some customers as they have effectively already paid to ride.
Average queuing time
Queuing will be seen by customers as dead time. They may see some waiting as inevitable and hence acceptable. However, TIP should be careful to maintain waiting
times at a minimum. An increase of 10 minutes (or 50%) is likely to be noticeable by customers and is unlikely to enhance the quality of the TIP experience for them. The
increase in waiting times is probably due to the high number of hours lost due to breakdown with customers being forced to queue for a fewer number of ride options.
Safety
The clear reduction in maintenance could easily damage the safety record of the park and is an obvious quality issue.
Risks
If TIP continues with current policies, then they will expose themselves to the following risks:
- The lack of routine maintenance could easily lead to an accident or injury to a customer. This could lead to compensation being paid or reputational damage.
- Increased competition. The continuous raising of admission prices increases the likelihood of a new competitor entering the market (although there are significant
barriers to entry in this market, e.g. capital cost, land and so on).
- Loss of customers. The value for money which customers see when coming to TIP is clearly reducing (higher prices, less reliability of rides and longer queues).
Regardless of the existence of competition, customers could simply choose not to come, substituting another leisure activity instead.
- Profit fall. In the end if customers' numbers fall, then so will profit. The shareholders, although well rewarded at the moment, could suffer a loss of dividend.
Directors' job security could then be threatened.
Workings:
(W9) Capacity of rides in hours is 360 days x 50 rides x 10 hours per day = 180,000.
20X4 lost capacity is 9,000/180,000 = 0·05 or 5%.
20X5 lost capacity is 32,000/180,000 = 0·177 or 17:8%.
Performance Management Question 2:
Carlos Co is an electronics company which makes two types of television - plasma screen TVs and LCD TVs. It operates within a highly competitive market and is constantly under pressure to reduce prices. Carlos Co operates a standard costing system and performs a detailed variance analysis of both products on a monthly basis. Extracts from the management information for the month of November are shown below:
|
Note |
||
|
Total number of units made and sold |
1,400 |
1 |
|
Material price variance |
$28,000 A |
2 |
|
Total labour variance |
$6,050 A |
3 |
Notes:
-
The budgeted total sales volume for TVs was 1,180 units, consisting of an equal mix of plasma screen TVs and LCD screen TVs. Actual sales volume was 750 plasma TVs and 650 LCD TVs. Standard sales prices are $350 per unit for the plasma TVs and $300 per unit for the LCD TVs. The actual sales prices achieved during November were $330 per unit for plasma TV and $290 per unit for LCD TVs. The standard contributions for plasma TVs and LCD TVs are $190 and $180 per unit respectively.
-
The sole reason for this variance was an increase in the purchase price of one of its key components, X. Each plasma TV made and each LCD TV made requires one unit of component X, for which Carlos Co's standard cost is $60 per unit. Due to a shortage of components in the market place, the market price for November went up to $85 per unit for X. Carlos Co actually paid $80 per unit for it.
-
Each plasma TV uses 2 standard hours of labour and each LCD TV uses 1.5 standard hours of labour. The standard cost for labour is $14 per hour and this also reflects the actual cost per labour hour for the company's permanent staff in November. However, because of the increase in sales and production volumes in November, the company also had to use temporary labour at the higher cost of $18 per hour. The total capacity of Carlos Co's permanent workforce is 2,200 hours production per month, assuming full efficiency. In the month of November, the workforce were wholly efficient, taking exactly 2 hours to complete each plasma TV and exactly 1.5 hours to produce each LCD TV. The total labour variance therefore relates solely to the temporary workers, who took twice as long as the permanent workers to complete their production.
(a) Calculate the following for the month of November, showing all workings clearly:
(i) The sales price variance and sales volume contribution variance;
(4 marks)
(ii) The material price planning variance and material price operational variance;
(2 marks)
(iii) The labour rate variance and the labour efficiency variance.
(5 marks)
(b) Explain the reasons why Carlos Co would be interested in the material price planning variance and the material price operational variance.
(9 marks)
(20 marks)
Answer (Detailed Solution Below)
Performance Management Question 2 Detailed Solution
(a)
(i) Sales price variance and sales volume variance
(ii) Material price planning and purchasing operational variances
Material planning variance = (original target price - general market price at time of purchase) x quantity purchased ($60-$85) x 1,400 = $35,000 A
Material price operational variance = (general market price at time of purchase actual price paid) x quantity purchased ($85 - $80) x 1,400 = $7,000 F
(iii) Labour rate and labour efficiency variances
Labour rate variance = (standard labour rate per hour - actual labour rate per hour) x actual hours worked
Actual hours worked by temporary workers:
Total hours needed if staff were fully efficient = (750 x 2) + (650 x 1-5) = 2,475.
Permanent staff provide 2,200 hours, therefore excess = 2,475 – 2,200 = 275.
However, temporary workers take twice as long, therefore hours worked = 275 x 2 = 550.
Labour rate variance relates solely to temporary workers; therefore ignore permanent staff in the calculation.
Labour rate variance = ($14 - $18) x 550 = $2,200 A
Labour efficiency variance = (standard labour hours for actual production - actual labour hours worked) x standard rate (275-550) x $14 = $3,850 A
(b) Explanation of planning and operational variances
Before the material price planning and operational variances were calculated, the only information available as regards material purchasing was that there was an
adverse material price variance of $28,000. The purchasing department will be assessed on the basis of this variance, yet, on its own, it is not a reliable indicator of
the purchasing department's efficiency. The reason it is not a reliable indicator is because market conditions can change, leading to an increase in price, and this
change in market conditions is not within the control of the purchasing department.
By analysing the materials price variance further and breaking it down into its two components - planning and operational - the variance actually becomes a more
useful assessment tool. The planning variance represents the uncontrollable element and the operational variance represents the controllable element.
The planning variance is really useful for providing feedback on just how skilled management is in estimating future prices. This can be very easy in some
businesses and very difficult in others. Giving this detail could help to improve planning and standard setting in the future, as management will be increasingly
aware of factors which could create volatility in their forecasts.
The operational variance is more meaningful in that it measures the purchasing department's efficiency given the market conditions which prevailed at the time. As
can be seen in Carad, the material price operational variance is favourable which demonstrates that the purchasing department managed to acquire the component
which was in short supply at a better price than expected. Without this breakdown in the variance, the purchasing department could have been held accountable for the
overall adverse variance which was not indicative of their actual performance. This is then a fairer method of assessing performance and will, in turn, stop staff from
becoming demotivated.
Performance Management Question 3:
Comprehension:
Zak Co
Zak Co is a large supplier of industrial metals. The company is split into divisions: Division F and Division N. Each division operates separately as an investment centre, with each having full control over its non-current assets. In addition, both divisions are responsible for their own current assets, controlling their own levels of inventory and having full responsibility for the credit terms granted to customers and the collection of receivables. Similarly, each division has full responsibility for its current liabilities and deals directly with its own suppliers. All cash balances are automatically transferred to a company bank account at the end of each day and are not therefore included in the definition of divisional capital.
The following figures relate to two of the divisions, Division F and Division N for the most recent financial year:
|
Division F |
Division N |
|
|
$000 |
$000 |
|
|
Sales |
14,500 |
8,700 |
|
Controllable profit |
2,645 |
1,970 |
|
Less apportionment of head office costs |
(1,265) |
(684) |
|
Net profit |
1,380 |
1,286 |
|
Non-current assets |
9,760 |
14,980 |
|
Inventory and trade receivables |
2,480 |
3,260 |
|
Trade payables |
2,960 |
1,400 |
Question
1.
Which of the following measures would be appropriate for assessing the performance of the managers of a profit centre?
- % of products returned for warranty repairs each year
- Sales price and volume variances
- Operating profit after deducting depreciation
- Residual income
Answer (Detailed Solution Below)
Performance Management Question 3 Detailed Solution
The correct option is option 1
Additional Information:
- (1) and (2) would be appropriate measures of the performance, as they are within the control of the managers of the divisions and reflect quality of output, and ability to sell the products. (3) is not appropriate, as profit centre managers cannot make investment decisions, so it would be unfair to deduct deprecation from their profit. Similarly residual income would not be appropriate – as managers of a profit centre cannot make investment decisions, it is not fair to evaluate their performance by a measure that deducts the cost of capital from their profit.
Performance Management Question 4:
Comprehension:
Zak Co
Zak Co is a large supplier of industrial metals. The company is split into divisions: Division F and Division N. Each division operates separately as an investment centre, with each having full control over its non-current assets. In addition, both divisions are responsible for their own current assets, controlling their own levels of inventory and having full responsibility for the credit terms granted to customers and the collection of receivables. Similarly, each division has full responsibility for its current liabilities and deals directly with its own suppliers. All cash balances are automatically transferred to a company bank account at the end of each day and are not therefore included in the definition of divisional capital.
The following figures relate to two of the divisions, Division F and Division N for the most recent financial year:
|
Division F |
Division N |
|
|
$000 |
$000 |
|
|
Sales |
14,500 |
8,700 |
|
Controllable profit |
2,645 |
1,970 |
|
Less apportionment of head office costs |
(1,265) |
(684) |
|
Net profit |
1,380 |
1,286 |
|
Non-current assets |
9,760 |
14,980 |
|
Inventory and trade receivables |
2,480 |
3,260 |
|
Trade payables |
2,960 |
1,400 |
Question
1.
| Division A | Division B | |
| Capital required for the project | $32.6m | $22.2m |
| Sales generated by project | $14.4m | $8.8m |
| Operating profit margin | 30% | 24% |
| Cost of capital | 10% | 10% |
| Current return on investment of division | 15% | 9% |
Answer (Detailed Solution Below)
Performance Management Question 4 Detailed Solution
The correct option is option 1
Additional Information:
| Division | A | B |
| Profit | $14.4m × 30% = $4.32m | $8.8m × 24% = $2.112m |
| Imputed interest charge | $32.6m × 10% = $3.26m | $22.2m × 10% = $2.22m |
| Residual income | $1.06m | $(0.108)m |
Performance Management Question 5:
Comprehension:
Zak Co
Zak Co is a large supplier of industrial metals. The company is split into divisions: Division F and Division N. Each division operates separately as an investment centre, with each having full control over its non-current assets. In addition, both divisions are responsible for their own current assets, controlling their own levels of inventory and having full responsibility for the credit terms granted to customers and the collection of receivables. Similarly, each division has full responsibility for its current liabilities and deals directly with its own suppliers. All cash balances are automatically transferred to a company bank account at the end of each day and are not therefore included in the definition of divisional capital.
The following figures relate to two of the divisions, Division F and Division N for the most recent financial year:
|
Division F |
Division N |
|
|
$000 |
$000 |
|
|
Sales |
14,500 |
8,700 |
|
Controllable profit |
2,645 |
1,970 |
|
Less apportionment of head office costs |
(1,265) |
(684) |
|
Net profit |
1,380 |
1,286 |
|
Non-current assets |
9,760 |
14,980 |
|
Inventory and trade receivables |
2,480 |
3,260 |
|
Trade payables |
2,960 |
1,400 |
Question
1.
- Delay payments to suppliers because of limited cash
- Delay an investment in a new computer system
Answer (Detailed Solution Below)
Performance Management Question 5 Detailed Solution
- Delaying payments to suppliers reduces the division’s capital, since payables reduces the net assets of the division, while cash balances are transferred to the central bank account of the company and not therefore included in capital. The first action would therefore increase the ROI and therefore the bonus of the manager.
- An investment in a computer system would increase the capital of the division thereby reducing the ROI. Delaying the investment will therefore increase the ROI and the bonus received by the manager, even though it may not be in the long term interests of the company to continue to use an out of date system.
Top Performance Management MCQ Objective Questions
Performance Management Question 6:
Jessie Co manufactures a single product. The following estimates of costs have been made for various level of production of the product.
| Production (units) | 50,000 | 70,000 | 100,000 |
| $000 | $000 | $000 | |
| Variable | 3,655 | 5,117 | 7,310 |
| Fixed | 3,452 | 3,452 | 3,452 |
In addition to the costs listed above, $380,000 of incremental costs will be incurred for every complete 20,000 units produced.
What is the budgeted total production cost if production is budgeted to be 85,000 units?
Answer (Detailed Solution Below)
Performance Management Question 6 Detailed Solution
The correct option is option 3.
Variable cost per unit = $7,310,000/100,000 = $73.10 (or calculate as $5,117,000/70,000).
Incremental costs incurred at 85,000 units is 4 increments of 20,000.
Therefore, total production cost = ($73.10 × 85,000) + $3,452,000 + ($380,000 × 4) = $11,185,500
Tutorial note: The question will indicate the number of fixed cost increments. In this case, the cost occurs after 20,000 units are completed, so a production level of 85,000 units incurs four increments.
Performance Management Question 7:
Parma Co requires all divisions to prepare their own budgets and these are then approved by head office. The current managing director of Parma Co believes that it would be better if all budgets for the divisions are prepared centrally at head office, and divisional managers told that they must aim to achieve them.
Which of the following is an advantage of non-participative budgeting as compared to participative budgeting?
Answer (Detailed Solution Below)
Performance Management Question 7 Detailed Solution
The correct option is option 2.
Additional information:
In comparison to participative budgeting, an advantage of non-participative budgeting is that it should be less time consuming, as less collaboration will be required in order to produce the budgets.
Performance Management Question 8:
Amelpa Co manufactures a range of industrial products. The budgeted costs of the maintenance section for the current 12 month period have been analysed as follows:
| $ | |
| Routine maintenance | 151,000 |
| Production line set up | 42,000 |
| Total | 193,000 |
The budget was prepared on the basis that there will be 720 set ups and that 10,080 machine hours will be worked. The company has received an enquiry for an order which requires three set ups and will take 56 machine hours.
How much (to the nearest $) regarding costs associated with the maintenance section should be included in the cost of the order?
Answer (Detailed Solution Below)
Performance Management Question 8 Detailed Solution
The correct option is option 2.
Additional information:
| Set up $42,000/720 set ups | = $58.33 per set up × 3 set ups | = | $175 |
| Routine $151,000/10,080 hours | = $14.98 per hour × 56 hours | = | $839 |
| Total | = | $1,014 |
Performance Management Question 9:
The finance function of Bagnall Co has been asked to oversee the production of the company’s budgets for the forthcoming year. In its initial instructions to the company’s various divisions the finance function has stressed that once budgets for next year have been formally agreed steps will be taken to maintain their ongoing relevance by undertaking a monthly review of budgets for forthcoming months in the light of performance in earlier months.
Which of the following best describes this approach to budgeting?
Answer (Detailed Solution Below)
Performance Management Question 9 Detailed Solution
The correct option is option 4.
Additional information:
Rolling budgeting means that as each month goes by, the budgets for the months ahead are reviewed and, if necessary, revised so that they remain relevant for the remainder of the budget period.
Performance Management Question 10:
Bright Co produces quarterly rolling budgets and had forecast the costs of material purchases for the next four quarters (Q1, Q2, Q3 and Q4). Purchases for Q1 were budgeted to be $220,000 and it was anticipated that the cost of materials would rise at a rate of 2% per quarter.
At the end of Q1:
- Actual material purchases were recorded at $210,000. This was due to a change of material supplier during the quarter.
- A revised estimate for the increase in material purchase costs was made. The rise was now predicted to be only 1% per quarter.
- The budget was updated.
What estimate for total annual material purchases should be recorded in the updated budget?
Answer (Detailed Solution Below)
Performance Management Question 10 Detailed Solution
The correct option is option 2.
Additional information:
When using rolling budgets, two things happen at the end of an accounting period (month or quarter):
- the remaining budget for the year is updated based on the actual results and the up to date information available, and
- a further accounting period (month or quarter) is added.
In this way there will always be a full year’s budget available.
WORKING
The total annual material purchases will be the sum of the next four quarters (i.e. Y1 Q2, Q3 and Q4) plus the first quarter of the following year (Y2 Q1). The budgets for these quarters will have been updated based on the actual material purchases from Q1 ($210,000) and the predicted cost increase of 1%.
| Y1 Q1 | Y1 Q2 | Y1 Q3 | Y1 Q4 | Y2 Q1 | |
| Actual | Budget | Budget | Budget | Budget | |
| Material purchases | $210,000 | $212,100 | $214,221 | $216,363 | $218,527 |
The total annual material purchases figure in the updated rolling budget would therefore be $212,100 + $214,221 + $216,363 + $218,527 = $861,211
Performance Management Question 11:
The following statements have been made about changing budgetary systems:
- The costs of implementation may outweigh the benefits
- Employees will always welcome any new system which improves planning and control within the organisation
Which of the above statements is/are true?
Answer (Detailed Solution Below)
Performance Management Question 11 Detailed Solution
The correct option is option 1.
Additional information:
(1) is true as it is possible that the costs of a new budgetary system may outweigh the benefits. (2) is not true. Employees are likely to resist new budgetary systems as they may involve additional work, and may be viewed as managers trying to achieve greater control.
Performance Management Question 12:
The following statements have been made about zero based budgeting:
- Employees will focus on eliminating wasteful expenditure
- Short-term benefits could be emphasised over long-term benefits
Which of the above statements is/are true?
Answer (Detailed Solution Below)
Performance Management Question 12 Detailed Solution
The correct option is option 4.
Additional information:
(1) is true – ZBB focusses on only including costs relating to activities that the organisation wishes to continue to perform. Costs will not be included in the budget simply because they were in previous years’ budgets.
(2) is true. Budgets are mainly financial, and management may focus on increasing budgeted profits by removing expenses on activities that may benefit the organisation in the longer term.
Performance Management Question 13:
Tree Co is considering employing a sales manager. Market research has shown that a good sales manager can increase profit by 30%, an average one by 20% and a poor one by 10%. Experience has shown that the company has attracted a good sales manager 35% of the time, an average one 45% of the time and a poor one 20% of the time.
The company’s normal profits are $180,000 per year and the sales manager’s salary would be $40,000 per year.
Based on the expected value criterion, which of the following represents the correct advice which Tree Co should be given?
Answer (Detailed Solution Below)
Performance Management Question 13 Detailed Solution
The correct option is option 1.
Additional information:
New profit figures before salary paid:
Good manager: $180,000 × 1.3 = $234,000
Average manager: $180,000 × 1.2 = $216,000
Poor manager: $180,000 × 1.1 = $198,000
EV of profits = (0.35 × $234,000) + (0.45 × $216,000) + (0.2 × $198,000) = $81,900 + $97,200 + $39,600 = $218,700
Deduct salary cost and EV with manager = $178,700
Therefore, do not employ manager as profits will fall by $1,300.
Performance Management Question 14:
A company is considering whether to develop and market a new product. The cost of developing the product is estimated to be $150,000. There is a 70% probability that the development will succeed and a 30% probability that the development will be unsuccessful.
If the development is successful, the product will be marketed. There is a 50% chance that the marketing will be very successful and the product will make a profit of $250,000. There is a 30% chance that the marketing will be reasonably successful and the product will make a profit of $150,000 and a 20% chance that the marketing will be unsuccessful and the product will make a loss of $80,000. These profit and loss amounts take account of the $150,000 development cost.
What is the expected value of the decision to develop and market the product?
Answer (Detailed Solution Below)
Performance Management Question 14 Detailed Solution
The correct option is option 3.
Additional information:
The following decision tree shows all profit and loss outcomes after deducting the $150,000 development costs:
EVB = 154,000 ((250,000 × 50%) + (150,000 × 30%) + (−80,000 × 20%))
EVA = (154,000 × 70%) + (−150,000 × 30%) = 62,800
Therefore the EV of the decision to market the product is $62,800.
Performance Management Question 15:
FP can choose from three mutually exclusive projects. The net cash flows from the projects will depend on market demand. All of the projects will last for only one year. The forecast net cash flows and their associated probabilities are given below:
| Market demand | Weak | Average | Good |
| Probability | 0.30 | 0.50 | 0.20 |
| Project A | 400 | 500 | 600 |
| Project B | 300 | 350 | 400 |
| Project C | 500 | 450 | 650 |
FP can commission a forecast that would tell it with certainty what demand conditions will be before the decision is made about which project to invest in.
What is the maximum amount that FP should pay for the forecast?
Answer (Detailed Solution Below)
Performance Management Question 15 Detailed Solution
The correct option is option 3.
Tutorial note: The maximum amount that FP should pay is equal to the value of perfect information. This is the expected value (EV) with perfect information less EV without information.
Additional information:
EV without information
Project A ($400 × 0.3) + ($500 × 0.5) + ($600 × 0.2) = $490
Project B ($300 × 0.3) + ($350 × 0.5) + ($400 × 0.2) = $345
Project C ($500 × 0.3) + ($450 × 0.5) + ($650 × 0.2) = $505
Therefore, without perfect information, Project C would be chosen, as it has the highest EV, $505.
EV with perfect information
| If forecast predicts | Choose | Outcome | Probability |
| Weak demand | Project C | 500 | 0.3 |
| Average demand | Project A | 500 | 0.5 |
| Good demand | Project C | 650 | 0.2 |
EV with perfect information is (500 × 0.3) + (500 × 0.5) + (650 × 0.2) = $530
Therefore, value of perfect information is = ($530 − $505) = $25