Answers Specimen Exam Paper T4 Part B Case Study Nov09 · CIMA 2010 Chartered Management Accounting ... 3.0 Strategic Analysis and Position Audit 4.0 Review and prioritisation

CIMA 2010 Chartered Management Accounting Qualification – Answers for Specimen Examination Paper T4 – Part B Published November 2009

The Chartered Institute of Management Accountants 2009

The Examiner's Answers – Specimen Paper T4 – Part B Case Study Examination

Answer to Question 1

REPORT To: The Northern Divisional General Manager From: Divisional Management Accountant Date: November 2009 Contents 1.0 Introduction 2.0 Terms of Reference 3.0 Strategic Analysis and Position Audit 4.0 Review and prioritisation of issues faced by Northern Division 5.0 Approaches to resolving the main issues 6.0 Ethical considerations 7.0 Recommendations 8.0 Conclusion Appendices: Appendix 1 SWOT Analysis Appendix 2 Greiner’s model of the 5 stages of organisational development Appendix 3 Herzberg’s Motivation – Hygiene theory Appendix 4 Calculations in support of wind power estimates (based on 2008/9 electricity

generation and price levels) Appendix 5 Assessment of investment proposal for N1 and N2 1.0 Introduction The total output of electricity produced by the Northern Division in 2008/9 was 22,924 million kWh and its total costs were $6038 million. It will be necessary for NDGM, the newly appointed Northern Division General Manager, to change the culture and attitude of the employees of the division in order to improve the efficiency and effectiveness of the division’s performance. There appears to be considerable overlap of functions and responsibilities within EGC as a whole as support functions at headquarters are replicated within each division. There has been a significant increase in managerial and administrative staff in recent years. Decision making within EGC has been centralised but more autonomy in the divisions, within prescribed limits, has now been introduced. NDGM agrees with the other divisional general managers that more control over research and development should be provided within the divisions, in particular in respect of wind power development.


T4 – Part B Case Study 2 Answer for Specimen Paper

The Government provides financing to EGC to cover revenue expenditure not recovered through receipts from charges and all its capital expenditure. EGC charges the distribution companies for the electricity it supplies to them and has previously been guaranteed that any shortfall in its funding in any financial year is made up by the Government. As far as the Northern Division is concerned, the income generated by its electricity sales in 2008/9 was $5,043 million. Its total costs were $6,038 million resulting in a deficit overall of $995 million. There was a significant investment in non-current assets in 2008/9 across EGC, ($1,248m) representing 8.1% of the non current assets base as at 31 March 2008. This sum was spent on renewals of plant and equipment, 56% of which was in the Northern Division and was necessary to keep the plant and equipment operational to maintain generation of electricity at about the same level as in the previous year. The Minister of Energy has announced the development of other fuel sources besides coal for generating electricity but this will not include nuclear power generation methods. By November 2013, a large programme of wind turbines will be operational and they will be situated in the Northern Divisional area of EGC. The Northern Division has the opportunity to operate and manage the wind power programme. There are many examples of wind power turbines being erected in different countries, notably in the UK, Denmark and Germany. The emphasis by these governments is on reducing emissions and establishing methods of producing power by a renewable resource. This has become a charged political issue with the G8 and the OECD both making strong reference to the need for reduced emissions to slow the impact of climate change. The Northern Division is becoming increasingly subject to the threat of damage by earth tremors. Power station N4 has been damaged and repairs, costing $1500 million at 2008/9 prices, should be carried out within 5 years to guarantee maintenance of the station’s generation of electricity at its capacity. N4 is Northern Division’s best performing power station and achieved 83% of capacity utilisation in 2008/9 at an average cost per kWh of $0.212 which, compared with the average cost per kWh for EGC as a whole of $0.2151, represented a reduction of nearly 2% on the overall EGC average. Currently EGC produces cost accounts annually and applies a simple headquarters overhead apportionment method. The annual cost account system is not fit for purpose especially in the new competitive environment in which the EGC divisions now find themselves. The divisions are now able to compete amongst themselves for the sale of electricity to the 10 distribution companies. By far the highest revenue expenditure item incurred by the Northern Division is the generating costs which account for about 83% of total costs. Capacity utilisation varies across divisions with the two worst performing power stations in the whole country being situated in the Northern Division. 2.0 Terms of Reference As Divisional Management Accountant, the author of this report is responsible for prioritising, analysing and evaluating the issues facing the Northern Division and to make appropriate recommendations. NDGM seeks advice on how cultural change may be brought about within the Northern Division. This leads to consideration of which information systems are required and how they should be implemented in order to help the Northern Division to manage its business and deal with the priority issues it faces. A strategic analysis and position audit of the Northern Division follows in the next section. The key issues faced by the Northern Division are then reviewed and prioritised followed by a discussion of each and suggestions as to how they may be addressed. The ethical issues facing the Northern Division are then considered followed by a summary of the recommendations made in the report. At the end there is an overall conclusion. 3.0 Strategic Analysis and Position Audit (It should be noted that the Strategic Analysis and Position Audit is included for teaching purposes only. It is not expected that candidates will include a Strategic Analysis and Position


Answer for Specimen Paper 3 T4 – Part B Case Study

Audit in the main report within their examination answer. Marks are available though for strategic analysis in the appendices to the main examination answer provided by candidates.) The main Strengths, Weaknesses, Opportunities and Threats relating to the Northern Division are presented in Appendix 1. Strengths The major strength of EGC, and consequently its divisions, is that it is Government funded and engaged in a business entity that provides an essential product, that is electricity, and at present has a monopoly in terms of electricity generation in the country. It has significant capital investment in its infrastructure. EGC now operates through a divisional structure, which has provided greater autonomy to the divisions and has a sustainable customer base. Although EGC enjoys a monopoly position in respect of electricity generation at the moment, the Government could introduce competition into the industry in the future. Weaknesses The major weaknesses are an inappropriate culture and attitude among the work force of the Northern Division and poor management control. The management information systems are weak. NDGM and the general management team must have robust information systems on which to base decisions. The Northern Division has the poorest performing power stations in the whole of EGC, with power stations N1 and N2 utilising only 46% and 57% respectively of their total capacity in 2008/9. Recent earth tremor activity has caused damage to power station N4 and this will ultimately affect its performance. The Northern Division incurs the highest expenditure of all the three divisions on repairs and renewals to plant and equipment. Opportunities Both EGC and the divisions now have new leadership. NDGM recognises the need to develop more effective control systems to manage the division in both strategic and operational terms. A major opportunity has now been presented by the Minister of Energy with the development of wind powered electricity generation. In addition, there is an investment proposal to improve the fuel efficiency and reduce the harmful emissions of power stations N1 and N2. It is necessary for NDGM to consider these opportunities on their merits as it may not be worthwhile to undertake them all. Threats The major threat to the Northern Division is the competition from the other divisions of EGC. The fact that the Northern Division’s performance in terms of output and cost efficiency is worse than the other divisions makes it more difficult for the division to provide effective competition. On top of this, the Government is insisting on improvements in efficiency especially with regard to the management and operation of the wind powered generation programme. EGC is still required to repay the Government loans and this will impose a discipline on all the divisions to improve their efficiency. However, this will affect the Northern Division more as its performance is worse than the other two divisions. There is therefore the threat of closure of all or part of the Northern Division especially if it is not awarded the management and operation of the wind power programme. The increase in the incidence of earth tremors in the Northern Division’s area is also a danger to all buildings and will require major investment to ensure that the power stations are able to withstand the threat. According to Mendelow’s power / interest matrix it is clear that there are no stakeholders who do not have any interest in the electricity generating industry. Electricity is an essential product and everyone in the country is to some extent dependent on it. The greatest power is currently wielded by the Government. Employees are also in a position of strength as concerted industrial action could severely disrupt electricity generation. Currently the Northern Division, like the rest of the EGC divisions, is dependent on coal for fuel to run its power stations. Coal fuel does however lead to harmful emissions.



EGC as a whole is located within Stage 4 of Greiner’s 5 stages of growth model (Appendix 2). It is evident therefore that the divisions are affected by the characteristics of this stage of Greiner’s model. The Northern Division is centrally monitored and there is limited decision making at the divisional level. It seems apparent therefore that the division needs to co-ordinate activities better and reduce the red tape of bureaucracy which pervades it. NDGM however needs to ensure that the Northern Division Management Board maintains control of development and does not stifle initiative. In addition, NDGM must persuade colleagues at EGC headquarters of the benefits of new developments where they are justified, in order to obtain their backing for the common good of EGC as a whole. Therefore, it is important that NDGM is able to demonstrate goal congruence between the Northern Division and EGC as a whole. If NDGM is able to achieve success in persuading colleagues to support initiatives in the Northern Division, this will help improve morale and increase motivation within the division. The major force affecting the Northern Division is the power of suppliers. This refers to power exerted by the Government in terms of finance, the potential for employees to take action to restrict generating activities and by the suppliers of coal for the power stations. These forces also affect the other two divisions within EGC and therefore a concerted approach should be developed by EGC to counter the threat they pose. The Northern Division is affected by internal industrial rivalry as now it faces competition from the other two divisions. This would be exacerbated if the contract for the management and control of the wind generators is not awarded to the Northern Division. There are numerous motivation theories and one such is shown in Appendix 3. The two factor theory by Herzberg is one which belongs to the content branch of motivational theory. In essence, the Northern Division Management Board must ensure that it provides appropriate hygiene factors as a pre-requisite to enabling employees to be satisfied by the content of their actual job if they are to be motivated to meet the critical challenges which lie ahead. 4.0 Review and prioritisation of issues faced by EGC The major issues which the Northern Divisional Management Board faces, are shown in priority order as follows: 1. Changing the culture of the division so that it meets the challenges it faces. This includes

developing the management structure of the division within the divisional framework now established by EGC.

2. Provision of appropriate management control information 3. Embracing the opportunity to manage and control the wind turbines and the new

investment proposal 4. Undertake the repairs to N4 5. Research and development 4.1 Changing the culture of the division so that it meets the challenges it faces. This includes developing the management structure of the division within the divisional framework now established by EGC. The main goal of the Northern Division is to improve its effectiveness and efficiency in electricity generation including the Division’s responsiveness to electricity demands at peak times. NDGM is clear that if the Northern Division is to become more effective and efficient, and indeed to survive as an electricity generator, there needs to be a major change in culture and attitude among the workforce which in turn will have a significant operational impact in the division. Clear examples of culture change can be seen in international organisations such as British Airways. This change in culture and attitude needs to be embraced within the new divisional structure of EGC and an important part of NDGM’s role will be to champion change and development not only in the division, but also within EGC as a whole. NDGM needs to persuade colleagues at headquarters of the value of supporting the developments proposed within the division, which will benefit EGC as a whole as well as the Northern Division. NDGM fully recognises that the change in culture and attitude is a pre-requisite for all other changes that will need to take place in the Northern Division. It is recognition of this that has prompted NDGM to request this report.



4.2 Provision of appropriate management control information. It is clear that the management control information currently provided is insufficient for the needs of the Northern Division to manage effectively. The adoption of stronger management information methods is essential for the achievement of improved control which will enhance the opportunity to achieve divisional goals and hence impact positively on morale. This in turn will help to create a cohesive culture and attitude in the division enabling it to develop and become a much stronger organisation. Currently, the “cost accounts” of EGC are prepared annually and all headquarters costs are equally divided and charged out to the three divisions. This approach may be simple to operate but is by no means sophisticated enough to satisfy the strategic or control requirements of each of the divisions. 4.3 Embracing the opportunity to manage and control the wind turbines and the new investment proposal This is the most important strategic development opportunity that is available to the Northern Division. The Northern Division has the opportunity to be awarded the contract to operate and manage the system. Even if the contract is awarded to another organisation, then N1 and N2 will be mothballed and only used for reserve capacity. The division would then effectively operate only with power stations N3 and N4 and the likelihood would be that EGC would rationalise the organisational structure by closing down the Northern Division as it now stands and re-allocating N3 and N4 to other divisions. NDGM has a major task ahead in persuading EGC and subsequently the Minister of Energy that the Northern Division is able to take on the operation and management of the wind power generation programme effectively and efficiently. The new investment proposal relating to increasing the fuel efficiency in power stations N1 and N2 needs to be carefully considered in this light as the Minister of Energy will want to see evidence of improvements in efficiency and effectiveness being made by the Northern Division before awarding it the contract for the operation and management of the wind turbines. There are many examples of power stations depleting the global “stock” of fossil fuels such as coal, (for example the Drax power station in the UK) and their operators making serious attempt to reduce the impact of the emissions they cause. NDGM needs to be fully aware of the importance of improving the efficiency and effectiveness of the two most inefficient power stations within the Division in order to persuade the Minister of Energy to award the wind power contract to the Northern Division. 4.4 Undertake the repairs to N4 N4 is the division’s most productive and efficient power station by a long way. Although it can continue for another five years, the damage that has been caused by the earth tremors needs to be repaired to ensure it continues to produce at near its capacity. In addition to the cost of the repairs ($1,500m at 2008/9 prices) a short term problem will be that the repairs will take six months to carry out, during which time the power station will be closed. Power Station N4 is critical to the achievement of acceptable performance levels by the Northern Division and therefore the repairs can be seen as essential because NDGM and his Management Board cannot afford to take the risk that the electricity output of N4 may reduce due to increased earth tremor activity. The repairs need to be considered alongside the wind power generation opportunity. 4.5 Research and development Continuation of the need to pursue research and development needs to be addressed by the Northern Division but this is partly contained within the priorities stated above. However, NDGM should oppose the proposal that EDGM takes control of the entire research function for EGC especially as the Northern Division has the opportunity to be awarded the contract for the operation and management of the wind turbines which inevitably would lead to more research into this form of power generation being undertaken. Given the opportunity to develop electricity generation by wind turbine, NDGM would wish to have control of his own research activity.



5.0 Approaches to resolving the main issues 5.1 Changing the culture of the division so that it meets the challenges it faces. This includes developing the management structure of the division within the divisional framework now established by EGC. The single main issue facing the Northern Division is improving its efficiency and effectiveness in order that it can meet the challenges which it faces for its survival. This is the single most important goal of the Northern Division to which all employees’ attention needs to be directed. This is so that the Northern Division can increase its operational efficiency and improve its responsiveness to demands for increased electricity generation at peak times. All the other issues are different facets of this single goal. It will be necessary to make major improvements to the provision of management information for strategic and control purposes in order to satisfy the major stakeholders, including the Government, and to determine what strategic and operational action needs to be taken to enhance the division’s likelihood of survival. This is a major task facing the senior management of the Northern Division in a short time frame. The first concern is that the culture of the Northern Division and EGC as a whole is not conducive to organisational change. The bureaucratic nature of the way the division has been managed in the past cannot be permitted to continue in a dynamic organisation which is now subject to internal competition. Changing the culture of an organisation is never simple or straightforward and it normally takes time. The change has begun though with the appointment of NDGM. All employees must be provided with incentives to act in a goal congruent way. In order to achieve the change in culture and attitude, the management team needs to quickly become aware of the competitive environment which it is entering. Formal training needs to be provided very quickly. Therefore it is recommended that a formal training programme on managing in a competitive large public sector organisation with internal competition be bought in and all the Northern Division Management Board members be required to attend. The programme of training needs to extend beyond the formal training programme itself and there may be a requirement for mentors to be engaged for each management board member. The course must address the issue of changing the division from a position where it was wholly dependent on Government funding to one in which it competes for sales revenue and spends within its annual cash limit. The competition faced by the Northern Division is from other divisions within EGC. In the past, there was no incentive for the divisions to compete with each other. This competitive environment will fundamentally change the dynamics of the relationships between the division’s staff and those in competing divisions. The training will be an expensive activity and may need a bespoke course to be developed by a reputable practically based training organisation. The course itself will demonstrate the need for good management information and encourage the development of new cutting edge technology. Change in culture needs to apply throughout the division. This means that the Northern Division Management Board has a major responsibility to communicate a message to the workforce that shows the direction in which the organisation needs to develop and the part played by all employees in achieving the Division’s goals. This will require a great deal of reassurance to employees especially with the potential introduction of new generating methods besides those with which they are familiar. The message needs to be conveyed that the Division will be subject to competition and that it needs to become more efficient in meeting the threat. However, this needs to be balanced with the notion that currently the Northern Division is well placed to embrace the new technology, particularly wind power generation because of its location but this will require new skills to be developed. It is recommended that NDGM embarks on an immediate programme of meeting with the Division’s operational, technical and administrative staff explaining in detail the challenges that lie ahead. It is further recommended that NDGM seeks the support of the EGC Chairman in presenting the message that although there are challenges, the Northern Division is well placed to tackle these, providing the culture of the Division changes to meet them. This means that staff in



the Division need to recognise that the previous inefficient and time consuming practices must change to an attitude which fully accepts that new methods of working will have to be embraced. Effective communication is vitally important. What must not happen is a hiatus period when there is little communication coming from NDGM and the Divisional Management Board, as this will lead to speculation and rumour, a guaranteed way of de-motivating staff. The message will need to be reinforced by other means including cascading information through different levels of management and by displaying posters in the Division’s buildings. The main way that the culture will change though is by deed not word. Staff need to see and experience the changes taking place and feel a commitment to achieving the overall goal of improving effectiveness and efficiency. A revision to the organisational structure within the division that is clearly communicated will help to develop the feeling that change is taking place. NDGM needs to establish the structure which is most suitable to enable the division to function in the most efficient and effective way. The commitment of the senior staff in the division is critical as they will have the functional responsibility for ensuring the operational efficiency of the division. NDGM therefore needs to be sure of their total commitment and it is therefore recommended that NDGM meets with each senior manager within the division individually to discuss the strategic development of the division. The incentive package must be set such that the senior staff are encouraged to achieve the goal of improved efficiency. In terms of the structure itself, it is recommended that NDGM develops and maintains a flat structure with few hierarchies. It is essential that the members of the Divisional Management Board have a clear understanding of what is happening at an operational level and the consequent financial implications. The structure within the division needs to reduce the bureaucracy to allow freedom of management action to be undertaken at the point where it is most effective. This will often be at the operational level itself. It is recommended that these reviews be carried out by external professional consultants in order to provide independence. In order to provide for consistency, NDGM should encourage the Chairman of EGC to take ownership of this initiative and order the implementation of structural change across all the divisions. That way, NDGM can present the review as an EGC rather than a divisional initiative, which may deflect some negative reaction by staff since it will affect the whole of EGC. This review is likely to result in redundancies and this issue is further discussed within the Ethics section of this report. Improving motivation does not necessarily mean that staff should be given pay incentives, although the introduction of performance related pay may create a stimulus for improved achievement of targets. Hygiene factors are important but according to Herzberg, there is also a need for motivators to be present. This is likely to come through increased levels of autonomy in decision making at the appropriate level within the division. Therefore the division needs senior staff who are strong, dynamic, business orientated motivators with an ability to think strategically as well as operationally. They need to see what needs to be done in the division to ensure that the major goal is met and that new technology in electricity generation is embraced. It is recommended therefore that objectives are clearly established for all members of the Divisional Management Board and progress towards their achievement by NDGM reviewed on an agreed and regular basis. NDGM needs to be clear that any Divisional Management Board member who is not committed to meeting the organisational goal should seek employment elsewhere and be encouraged to leave on condition that a financial package is accepted. 5.2 Provision of appropriate management control information. It is essential that the Northern Divisional Management Board members are provided with appropriate management information in order that they can pursue the strategic development of the division and also control its costs and improve its efficiency. This means that information on costs needs to be provided in a timely manner and the systems which are introduced must be contextualised to be suitable for the needs of the electricity generating industry. NDGM will set objectives for members of the Management Board. This means that the board members will need to be provided with systems which aid strategic planning as well as provide for management control, responsibility accounting and budgetary control. They will also need



information on the measurement of their operational performance. Otherwise they are unable to measure their progress towards meeting targets and NDGM will not be able to review their performance adequately. It is clear that the existing management accounting system in operation in EGC is inadequate. It is recommended that a system of Activity Based Costing leading to Activity Based Management is introduced. Realistically though, given the need to analyse what drives costs, this cannot be introduced quickly. That however, should not be a deterrent to starting to implement such a system. In the first instance it is recommended that I lead the finance function in undertaking a complete analysis of the main cost components, breaking them down into their cost type, volume and frequency. This needs to be split down into the various activities including labour, materials and overheads to enable a proper cost classification to take place. It is recommended that a target date is set by which all the cost components of the division are classified even if these are under relatively broad headings for example “electrical engineering basic salaries”, “engineering overtime” and “engineering bonus payments” for pay items. Non pay items should also be classified for example into coal purchases according to size and provenance. If necessary, the Northern Division should engage temporary staff to carry out this cost classification activity as this will form the basis of the activity based costing exercise which will follow. The classification exercise should not restrict itself to generating activities but should also encompass administrative functions as well. It is inevitable that a robust computer system will need to be implemented to record these cost classifications. It is therefore recommended that NDGM seeks to obtain agreement from other divisional general managers to pool resources to establish a robust method of cost classification as most costs will be common across all the divisions. It is further recommended that NDGM volunteers the Northern Division as a pilot for implementing the collection of the data necessary to feed into the eventual management control system. By necessity, agreement will need to be reached quickly on the system which should be acquired but this may be time consuming. Therefore it is recommended that NDGM is able to demonstrate to the other divisional general managers that the Northern Division is well ahead in gathering the data which will be input into the system and makes proposals for the development of the system which most suits the needs of the Northern Division. This means that NDGM needs to have a clear view of the system which is most suitable. The prime objective for NDGM is to improve efficiency and ensure effectiveness. That means that it is necessary to ensure that the generation of the electricity meets the demand required including being able to accommodate peaks. This inevitably means that the Northern Division must have a customer focus as well as a mechanism of controlling its financial position. In order to engineer improvements in costs and effectiveness, the Northern Division needs to constantly review its internal business processes and learn from its experiences. All this leads to the recommendation that the Balanced Score Card (BSC) be implemented. This approach will enable the Divisional Management Board to review the achievement of its goals from the four perspectives of finance, customers, internal business processes and learning and growth. In addition, the Northern Division has another perspective to consider that is from the point of view of EGC itself. This may be called the “overview” perspective. Inevitably, EGC will be interested in the performance of the Northern Division in respect of the four core perspectives. Therefore the overview perspective will consist of the consolidation of the information provided by the four cores into an overall management report for EGC. This will be a summary of the detail delivered to the Northern Divisional Management Board. This consolidated summary for EGC will be drawn from the core perspectives. The information provided to the Divisional Management Board will have detail backing it up and will show the consequences of previous actions and project the outcomes of future activity. This can be summarised into a higher level report for EGC’s purposes. It is recommended that NDGM appoints a project leader within the division whose sole responsibility is to oversee the BSC’s implementation, commencing with the classification of costs. The project leader must have seniority and will report directly to NDGM. The expertise gained in becoming a qualified Chartered Management Accountant helps to provide the Divisional Management Accountancy role with the ideal credentials to undertake the



task of project leadership. The implementation of the BSC will form part of the objectives set for the members of the Management Board. It is further recommended that the following measures relating to the BSC are established in the first instance: Financial measures: Measures of profitability including economic value added Budgetary control information and comparison of actual costs with standards Provision of financial and performance information to the level where decisions and action can best be taken to provide effective control Cash flow and cash balances Return on investment of the division overall Provision of the return on investment and residual income for new capital projects Calculation of the asset base and the impact of depreciation Measurement of progress towards achieving financial targets Customer measures: Customer satisfaction across the whole range of users of electricity Benchmarking with other organisations that provide a service to the public in order to establish best practice in providing customer service Profitability obtained from each of the 10 independent distribution companies Establish the ratio of employees per customer (and final user if this information is available) and benchmark with the other divisions Market share in comparison with other divisions Internal Business Process Perspective measures: Developments of new technology Improvements in techniques Benchmarking with other divisions and organisations on establishing best practice in methods of generating electricity Operational efficiency in terms of capacity usage and unnecessary wastage Calculation of the cost of generation in each power station and for the division as a whole on a regular (daily) basis Calculation of kWh generated per employee and also broken down to kWh produced per operational employee Review of employee turnover Satisfaction of customer requirements after sales have been completed, e.g. response times to distribution company complaints Measurement of harmful emissions Availability of real time accurate information Learning and growth perspective measures: Reduced level of repetition of mistakes Skill requirements Employee satisfaction, retention and training Measurement of improvements in efficiency and output Review of outcomes from terminal staff interviews Research and development activities It is likely that the Northern Division will need to engage the services of a consultant to advise on the precise measures which need to be implemented. The generic headings for measures given above can be established relatively quickly although the capture of the information will be more time consuming. Establishing the measures is only the first step. If the benefits of implementing the BSC are to be obtained, it is essential that effective management action is taken on receipt of the information. It is recommended that NDGM instructs the project leader to advise on the training packages that need to be provided to the Division’s managers in order to make best use of the system once implemented.



It should be noted, in the context of the financial perspective, that the cost of producing one kWh of electricity in 2008/9 within EGC as a whole was $0.2151, a very marginal increase on the cost of $0.2145 in 2007/8. It is assumed that the fixed costs within the heading of “generating costs” are more or less consistent between the two years. If this is the case the variable cost of the incremental output of 2,000 million kWh in 2008/9 over 2007/8 was $0.2325, indicating that EGC was subject to cost inflation in 2008/9 on its incremental production. This is not surprising as it would be expected that variable costs will only behave in a linear manner within the relevant range and EGC is straining to maintain its production at the highest output level possible in order to meet demand. What is a surprise is the amount by which the variable costs per kWh appear to have increased. A major concern is that the incremental variable cost of generation per kWh was in fact higher than the revenue obtained for each kWh of electricity sold in 2008/9.

Examiner’s note: It could be argued that an alternative measure of variability is the generating costs (including fuel). It depends how many true variables are contained in the remaining six cost headings and this information is not available. The changes in some of these costs could be fixed cost steps. If variability is assessed using only the generating cost change, then the incremental output would cost $0.1355 per kWh.

5.3 Embracing the opportunity to manage and control the wind turbines and the new investment proposal. The Minister of Energy’s announcement of the installation of wind turbines by November 2013 can be regarded either as an opportunity or a threat to the Northern Division. As the implementation will take place anyway, it is more constructive to regard it as an opportunity. It is for the Northern Division to demonstrate that it has the capability to operate and manage the system effectively and efficiently in order to persuade the Minister to appoint EGC and the Northern Division in particular to this role. The task for NDGM is to change the culture of the Northern Division to enable it to embrace the challenge of meeting the targets imposed by the Minister of Energy. The Northern Division must show that in the first year after implementation the overall average cost of electricity generation across EGC will be no more than $0.183 per kWh at 2008/9 price levels and produce a plan to reduce harmful emissions by an average of 2% per year for 10 years commencing in 20010/11. The average cost of electricity generation for EGC as a whole was $0.2151 per kWh and for the Northern Division it was $0.263 per kWh ($6038m / 22924m kWh) at 2008/9 price levels. Northern Division needs power stations N3 and N4 as it requires their capacities to meet electricity demands. It must therefore manage a project which targets the worst performing power stations in the division, recognising that for each power station scaled down there will be a reduction in operating costs of $570 million. Power Stations N1 and N2 are the worst performing in the whole of EGC. These would be scaled down and only used as a reserve power source after the wind turbines become operational. The total volume of electricity estimated to be produced after implementation of the wind power programme will be 64,796 million kWh based on 2008/9 output. This is above the output required by the Government which is 64,500 million kWh by November 2013. The cost of generating the electricity by EGC as a whole at 2008/9 prices would be $0.182 per kWh which is lower than the Government’s target of $0.183 per kWh at 2008/9 prices. Appendix 4 provides the calculations in support of these estimates. Therefore the financial target set by the Minister of Energy would be met providing the estimates of the reduction in the annual operating costs of the division by $570 million per power station placed on standby are achieved. Power Stations N1 and N2 emit 65% of the Northern Division’s harmful emissions. The Northern Division emits about 42% of the total harmful emissions for EGC as a whole, this means that N1 and N2 account for 27.3% of EGC’s total emissions. No details are given on the tonnage that this represents, but given the second target set by the Government is a modest average of 2% reduction per year for 10 years, this amounts to 22% at a compound rate over the period. Therefore, scaling down N1 and N2 would mean that the Government’s second target would be



exceeded immediately except for the occasions when they need to be brought on stream as supplementary generators. It is clear that the implementation of the wind power programme will enable N1 and N2 to be scaled down and the Government’s financial and harmful emission targets to be met. However, the Northern Division must acquire the necessary skills to operate the wind turbines. This is likely to involve the need to develop training and therefore it is recommended that NDGM immediately establishes a training programme in the techniques of wind power generation maintenance and identifies appropriate staff to undergo this training. This then leads to the consideration of the investment proposal to increase fuel efficiency in N1 and N2 at a capital cost of $1,800 million. At first sight it would appear that this would not seem sensible if N1 and N2 are to be scaled down in or before November 2013. However, they are to be scaled down, not closed down. This means that they will be required from time to time to provide supplementary generation of electricity. When they are required it would be desirable that they operate more efficiently and release fewer harmful emissions. Further, it is not certain that the Minister of Energy will appoint the Northern Division to operate and manage the wind turbine programme and so, in order to encourage him to award the contract to the Northern Division, there needs to be some evidence provided that the Division is making a determined effort to improve its efficiency and reduce harmful emissions. Appendix 5 provides calculations which review the investment proposal using the two investment criteria (Return on Investment and Residual Income) employed by EGC. The question arises as to whether the return on investment should be evaluated using gross or net book values. Since the Northern Division is required to submit capital investment proposals exceeding $100 million to the EGC Management Board for approval, it can be taken as far as this proposal is concerned, that the Northern Division is a profit centre, not an investment centre. On that basis it could be argued that the depreciation charge for the capital equipment of $180 million per year is not controllable by NDGM and therefore should be excluded from the Residual Income and Return on Investment calculations from the divisional point of view. This would result in a residual income calculation of $207 million and a Return on Investment of 17.5%. The counter argument, which the EGC Management Board could put forward, is that since the investment would not exist and consequently the depreciation would therefore be avoidable if the division were closed, the divisional contribution should be reported after the deduction of depreciation. In this case the Residual Income will be $27 million and the Return on Investment 8.33%. It is worth noting that EGC as a whole may be better served by taking the gross book value approach in determining the return on investment because this is more likely to lead to goal congruent behaviour by NDGM. A net book value approach would result in the return on investment increasing year by year as the cumulative effect of the depreciation charge reduces the denominator in the fractional calculation, thus discouraging future investment by NDGM. Irrespective of whether a gross book value or a net book value approach is adopted, the investment proposal provides positive Residual Income and Return on Investment calculations. This improves the position of both the Northern Division and EGC as a whole and therefore from a financial point of view should be accepted providing the efficiency savings in fuel and manpower can be achieved. The RoI for the investment proposal is greater than that achieved by EGC as a whole therefore there would be goal congruence and EGC benefits as the Northern Division is currently achieving a negative RoI. However, the power stations will be scaled down and so it is not clear how long they will remain operational. Given the fact that to implement the wind turbine power programme will result in the scaling down of N1 and N2 at an annual saving of $1,140 million, it then becomes evident that the cost of the project at $1,800 million is worthwhile if it results in persuading the Minister of Energy in favour of the Northern Division to operate and manage the programme. It is therefore recommended that the $1,800 million is spent on improving N1 and N2 and that NDGM proposes this to the EGC Management Board.



5.4 Undertake the repairs to N4 While power station N4 needs repairs these are not urgent. However, NDGM cannot afford to risk N4 being put out of action or susceptible to reduced generation output as a result of neglecting to carry out the repairs. N4 is the best performing power station in the Northern Division and ranks with E4 and W3 which are the best in the other divisions in terms of output. It is clear that N4 will play an important part in the Northern Division’s strategy of taking on board the operation and management of the wind turbine programme. EGC as a whole needs N4 operating at full capacity to meet the volume of electricity demanded by the Government. The repairs will take six months to complete and N4 will be closed in that period. Therefore there needs to be an alternative source of power to make up the amount of electricity that N4 produces for the period when the repairs are carried out. It should be noted that since N4 will only be out of action for 6 months, it is unlikely that the generating output of 8,513 million kWh for a full 12 month period (as per 2008/9 output levels) will be lost unless the repairs seriously over run. It is recommended that repairs are scheduled to be carried out after November 2013 when the wind power generators are fully operational. This would mean delaying the scaling down of N1 and N2 until the repairs to N4 have been carried out. The result of this would be that EGC as a whole would be able to generate a total in excess of 63,487 million kWh (60,000m + 12,000m – 8,513m) based on the 2008/9 output. If a prudent view is taken, that in fact the repairs take 12 months rather than six, this will leave a shortage of 1,013 million kWh, which is 1.6% below the Government target. If the repairs to N4 are scheduled for a period after November 2013 at a time when (i) there is normally least usage of electricity, (ii) the improvements in efficiency to N1 and N2 are achieved and (iii) improvements are made to power stations in other divisions, it is likely that this shortfall of 1,013 million kWh will be made up. If the pessimistic view of 12 months for the repair is unfounded and they are actually carried out over six months then there should not be any shortfall on the Government’s target output. It is recommended that NDGM explains this strategy to the EGC Management Board and that the Chairman of EGC briefs the Minister of Energy so that the cost of electricity generation during the period when the repairs are being carried out to N4 are not taken as being representative of the normal average cost which will be incurred across EGC as a whole in steady state running. It is essential that the Chairman of EGC persuades the Minister of Energy that NDGM’s proposal will allow the objectives of the Government, Northern Division and EGC as a whole to be met albeit with a six month delay in the achievement of the Government’s target for the average cost per kWh of electricity generation. The proposal put forward by NDGM will reduce the disruption in electricity generation to a minimum while the essential repairs to N4 are carried out. 5.5 Research and development Research and development needs to be undertaken at the point where it is most effectively carried out. The amount of research funding provided by EGC in 2008/9 was a paltry $11m, or less than 0.1% of total costs in the year. It is clear that EGC has not paid much attention to research and development in the past but this cannot be allowed to continue and the sums invested need to be a realistic amount. It is very likely that the provision of resources needs to be shared by the divisions for effective research and development to be undertaken which will permit co-ordination and collaboration between the divisions. Further, if the Northern Division is awarded the operational contract for the wind turbine programme, it is essential that additional research into this power generation method will need to continue. The Minister of Energy, in deciding on the award of the contract, will take into account the opportunity for further research and development activity. Having control of its own research and development within the Northern Division will enhance the case for receiving the award of the operation and management of the wind turbine programme. It is recommended that NDGM proposes to the EGC Chairman that research and development of new and improved methods of



electricity generation should continue but with greater influence being given to the Divisional General Managers on the form that research and development will take. It is further recommended that the Northern Division be given the responsibility and significant funding to carry out research into wind power generation to enhance its case for the award of the wind turbine operational contract by the Minister of Energy. 6.0 Ethical considerations 6.1 Pricing Although the objective of the Government is to keep electricity prices as low as possible the system which has been put in place allows the divisions to alter price and supply to the distribution companies on a daily basis. This is open to abuse as by restricting supply, the divisions could in theory, increase the price which would be an unethical practice. This is clearly not the intention of the Government and it would certainly damage the reputation of any division that did this. However, NDGM must ensure that this does not occur particularly in his own division despite the temptation to increase revenue. There is a great deal of disquiet in other countries regarding the pricing of utilities such as electricity and gas where there is potential for price fixing arrangements to take place through cartels. It is recommended that NDGM obtains a daily report on output of electricity generation from the Divisional Engineer and is furnished with a full explanation if there is an abnormal decrease or even increase in supply for a particular period from any power station. It is further recommended that this report is lodged with EGC and is placed in the public domain so as to transparently show that no artificial restrictions in supply have occurred. 6.2 Redundancies and retraining It is clear that the Northern Division, in its push to become more efficient, will need to review its staffing levels. This is likely to lead to redundancy among some of the workforce and also the need for re-training and re-skilling. The ethical issue is not that redundancies should be avoided altogether but that this needs to be handled sensitively with human resource specialists employed to ease the exit from the organisation of those employees whose skills are no longer required. There is no ethical imposition on the Northern Division or EGC as a whole to maintain employment where it is patently no longer required. The redundancy procedures and payments must at least be in accordance with relevant legislation. In the case of staff transferring to other roles or even to other divisions their terms of employment must be fully agreed with the trade unions beforehand and their pension rights, where applicable, protected. It is recommended that the issue of redundancies and retraining be undertaken by EGC’s Human Resource Management specialists backed up by the divisional HRM staff. Re-training of employees where appropriate, and in the best interests of the Northern Division, should be undertaken to avoid redundancy where possible. Transfer to other employment within EGC should also take place as far as possible in accordance with relevant legislation. However, where redundancy is unavoidable, the HRM staff in the Northern Division and at EGC headquarters should take every step to help staff to find alternative employment outside of EGC and assist with relocation expenses where applicable. The amount of assistance provided must be agreed with the trade unions beforehand. 6.3 Buildings in the earth tremor zone Although the Government has introduced strict construction regulations requiring all new buildings in the affected zone to be able to withstand earth tremors, this does not apply to existing buildings which are clearly at risk. The Northern Division Management Board has an ethical obligation to ensure the safety of all its work force and also for the continuity of power generation. The recommendation that repairs to the damaged N4 be carried out after the wind turbines programme has been implemented is reasonable given that the structural report on N4 is that it is safe for 5 years. If earth tremor activity is greater than expected then the Northern



Division and EGC may be faced with making repairs to N4 sooner than proposed. The other power stations however are unprotected. Their vulnerability to earth tremor activity should be reviewed. It is recommended that a thorough investigation is carried out on all the power stations and other buildings in the Northern Division and a programme drawn up to provide them with the necessary construction work to protect them from earth tremors in accordance with the Government regulations. This is so that the staff working in the buildings are safe and that electricity generation from the power stations is secured as far as possible. Funding for these works should be discussed as a matter of urgency at the EGC Management Board and also with the Minister of Energy. It is unlikely that any insurance can be obtained for the power stations and in any case the premiums are likely to be prohibitively expensive. Insurance cover would require the buildings to be in accordance with the building regulations in any case. 7.0 Recommendations 7.1 Cultural and structural change The most important goal to be achieved by the Management Board is to increase the efficiency and effectiveness of the Northern Division. All the other issues are different facets of this single goal. It is necessary therefore for a major shift in attitude to take place amongst the work force so that employees understand the need for them to strive to achieve this aim. This requires a change in the culture of the Division. The first step is to ensure that the Management Board members themselves are equipped to manage in the new environment in which the Northern Division finds itself. Therefore it is recommended that a formal training programme on managing in a competitive large public sector organisation with internal competition be bought in and all the Northern Division Management Board members be required to attend. Running in parallel with this, it is recommended that NDGM meets with each senior manager within the division individually to discuss strategic development. The incentive package for these managers must be set such that the senior staff are encouraged to achieve the goal of improved efficiency. The outcome of these meetings will be the setting of objectives for each senior manager to achieve. It is recommended therefore that objectives are clearly established for all members of the Management Board and progress towards their achievement by NDGM reviewed on an agreed and regular basis. In order to communicate the main goal of the Division to staff, it is recommended that NDGM embarks on an immediate programme of meeting with the division’s operational, technical and administrative staff explaining in detail the challenges that lie ahead. It is further recommended that NDGM seeks the support of the EGC Chairman in presenting the message that the Northern Division is well placed to tackle the challenges it faces, providing the culture of the division is such that it enables them to be met. NDGM must establish a structure which will enable the goal of improved efficiency and effectiveness to be achieved. It is recommended that NDGM develops and maintains a flat structure with few hierarchies. It is essential that the members of the Division’s Management Board are able to have a clear understanding of what is happening at an operational level and the consequent financial implications. It is important that NDGM delegates responsibility for action and technical problem solving to the staff who are best equipped and qualified to deal with these issues. There needs to be a direct line of report to the Management Board. The administrative, as well as the engineering structure of the division, needs to be reviewed. It is recommended that these reviews be carried out by external professional consultants in order to provide independence. 7.2 Management Control Information. It is essential that the Northern Divisional Management Board members are provided with appropriate management information in order that they can pursue the strategic development of the division and also control its costs and improve its efficiency. It is recommended that a system of Activity Based Costing leading to Activity Based Management is introduced. As a



starting point in introducing ABC, it is recommended that a target date is set by which all the cost components of the division are classified. As this is a system which is likely to benefit all divisions of EGC, it is recommended that NDGM seeks to obtain agreement from other divisional general managers to pool resources to establish a robust method of cost classification as most costs will be common across all the divisions. It is further recommended that NDGM volunteers the Northern Division as a pilot for implementing the collection of the data necessary to feed into the eventual management control system. In order to encourage speedy implementation of ABC, it is recommended that NDGM is able to demonstrate to the other divisional general managers that the Northern Division is well ahead in gathering the data which will be input into the system and makes proposals for the development of the system which most suits the needs of the Northern Division. As the Management Board needs to monitor the different perspectives of the Northern Division, it is recommended that the Balanced Score Card (BSC) be implemented. It is recommended that NDGM appoints a project leader within the division whose sole responsibility is to oversee the BSC’s implementation, commencing with the classification of costs. The project leader must have seniority and will report directly to NDGM. The implementation of the BSC will form part of the objectives set for the members of the Management Board. NDGM should instruct the project leader to advise on the training packages that need to be provided to the Division’s managers in order to make best use of the BSC system once implemented. 7.3 Management and control of the wind turbines. This is the most important strategic development opportunity available to the Northern Division. It is vital for the Division’s survival that it is awarded the contract to operate and manage the system. It is therefore recommended that NDGM immediately establishes a training programme in the maintenance of plant and equipment employed in wind power generation and identifies appropriate staff to undergo this training. It is further recommended that the $1,800 million is spent on improving N1 and N2 and that NDGM proposes this to the EGC Management Board. This is to encourage the Minister of Energy that the Northern Division is capable of operating and managing the wind turbines project and will ensure that when the need arises for N1 and N2 to be brought into service as back up, they operate more efficiently than at present . 7.4 Repairs to N4 Power Station N4 is critical to EGC as a whole as it is the best performing power station in the Northern Division. If the Government’s target for electricity generation is to be met then EGC needs N4 to be operating efficiently and close to its capacity. It is therefore recommended that repairs are scheduled to be carried out after November 2013 when the wind power generators are fully operational. This would mean delaying the scaling down of N1 and N2 until the repairs to N4 have been carried out. It is further recommended that NDGM explains this strategy to the EGC Management Board and that the Chairman of EGC briefs the Minister of Energy so that the cost of electricity generation during the period when the repairs are being carried out are not taken as being representative of the normal average cost which will be incurred across EGC as a whole in steady state running. 7.5 Research and development. It is recommended that NDGM proposes to EGC’s Chairman that research and development of new and improved methods of electricity generation should continue but with greater influence being given to the Divisional General Managers on the form that research and development will take. It is further recommended that the Northern Division be given the responsibility and significant funding to carry out research into wind power generation to enhance its case to be awarded the wind turbine operational contract by the Minister of Energy.



8.0 Conclusion The critical issues facing NDGM and the Northern Division Management Board are to: 1. Change the culture of the division so that it meets the challenges it faces. This includes

developing the management structure of the division within the divisional framework now established by EGC.

2. Provide appropriate management control information. 3. Embrace the opportunity to manage and control the wind turbines. 4. Undertake the repairs to N4. 5. Carry out research and development into wind turbine technology. The first issue is to change the culture of the division in order that it is able to improve its efficiency and effectiveness. This is the main goal and all the other issues follow on from this. The recommendations made in this report aim to assist NDGM and the Northern Divisional Management Board in achieving its main goal and set out to explain the priority order of activities to be undertaken, the management and control information systems which should be put in place and how they should be implemented to help the Division to manage its business and deal with the priority issues it faces.



Appendix 1 - SWOT Analysis Strengths Government funded organisation Significant capital infrastructure Oligopoly in market for electricity generation as divisions now compete Specific and sustainable customer base Improved divisional structure

Weaknesses

Unsatisfactory culture and attitude Poor management control Weak management information systems Poor system of overhead charging Lack of employee responsibility Inefficiency of Northern Division’s power stations, with highest levels of unit cost Poor capacity utilisation in the Northern Division Power station N 4 damaged High level of harmful emissions from the Northern Division Net loss in 2008/9 overall impacting adversely on EGC as a whole High expenditure on renewals of plant and equipment No clear strategy for R&D Power cuts have been experienced previously Costs of EGC are rising faster than selling prices which were regulated by the Government

Opportunities

New leadership of EGC and Northern Division Development of more effective management information systems Operational management and control of wind power development in Northern Divisional area New investment proposal to increase fuel efficiency in N1 and N2 Improvements in efficiency to increase power generation and reduce harmful emissions in

meeting Government targets.

Threats

Competitive environment internally within EGC may lead to redundancies Northern Division’s poor performance meaning that it does not compete effectively with Eastern and Western divisions Demands for efficiency from Government Supplies for coal fired power stations are threatened with increased coal extraction costs Repayment of Government loans affects all divisions Need to change culture of Northern Division likely to cause unrest Increasing incidence of earth tremors



Appendix 2 – Greiner’s model of the 5 stages of organisational development

Stage 1 - Growth through creativity

Creative ideas drive the organisation forward at its formative stage. A straightforward structure is required until there is a crisis of leadership because the organisation cannot continue with such a simple structure and there is a need for direction.

Stage 2 – Growth through direction

The organisation becomes more procedural in its approach and adopts systems for direction within a functional structure. The procedures in turn develop and eventually stifle ingenuity and creativity which leads to a crisis of autonomy and the need for a strategic approach to encourage individuality to blossom.

Stage 3 – Growth through delegation

More autonomy is provided by delegating responsibility and decisions are speeded up through decision making being made at the local level. A holding company is an appropriate structural format but individual decision making by subsidiary managers may lead to fragmentation and a crisis of control.

Stage 4 – Growth through co-ordination

Monitoring from the central unit of the organisation through a divisional structure permits decision making to be undertaken within prescribed limits and control from headquarters. The co-ordination and control mechanisms exercised by headquarters may lead to a crisis of red tape.

Stage 5 – Growth through collaboration

Working together in small teams to complete tasks which may be facilitated by a matrix structure. There may be other crises as a result of this, particularly loss of co-ordination and confusion by employees regarding to whom they should report. EGC as a whole appears to be in Stage 4, in that it is centrally monitored and there is limited decision making at the regional level. Therefore Northern Division is enmeshed within Stage 4 but NDGM and his team are desperately keen to become much more autonomous. The co-ordination and control exercised by headquarters gets in the way and there is a clear crisis of red tape with a highly bureaucratic structure. This has to some degree been recognised and more autonomy, within prescribed limits, has now been given to NDGM. A divisional structure with greater freedom of action at the divisional manager level would seem to be the most appropriate way forward. The structure on its own will not solve the problems faced by NDGM and the Northern Divisional Management Team. There is also a clear need to change the culture of the Northern Division.



Appendix 3: Herzberg’s Motivation – Hygiene Theory Frederick Herzberg proposed that there are two factors which lead to motivation of individuals. The “hygiene” factors are those which, if absent, result in dissatisfaction. These include salary, job security, conditions of employment, working conditions, the amount of supervision, the quality of supervision, company policy and administrative procedures and interpersonal relations in the work place. The “motivation” factors encourage an individual to perform better if they are present and relate to the job content of the work undertaken by the individual. These include sense of achievement, recognition of work well done, responsibility, the actual nature of the work and personal growth and advancement. According to Herzberg, an organisation needs to attend to the hygiene factors to prevent dissatisfaction. They do not on their own create motivation to perform better at work. In order for motivation to be present management need to ensure that the hygiene factors are present and that an individual is allowed to do things in work which are satisfying providing this is congruent with the organisational objectives. NDGM needs to ensure that employees are provided with fair and proper treatment and to avoid as much unpleasantness as possible. The Northern Division needs to ensure that salary levels and working conditions are appropriate. However, NDGM must also make sure that employees obtain job enrichment and job enlargement if they are to be motivated. It is likely that there is some dissatisfaction among the workforce given the bureaucratic nature of the organisation and the crisis of red tape as shown within Greiner’s model. The senior management of the Northern Division need to ensure that hygiene factors are in place to prevent dissatisfaction and then develop motivators by enabling personal growth and advancement where appropriate within the organisation.



Appendix 4 – calculations in support of wind power estimates (based on 2008/9 electricity generation and price levels)

Total kWh of electricity generation after implementation of the wind power programme: KWh

millionTotal electricity generated in 2008/9 60,000Estimate of generation by wind turbines 12,000 72,000Less output produced from N1 and N2 7,204Net output estimated after implementation 64,796 Average cost of electricity generated after implementation: Northern

Division EGC

$ million $ millionTotal costs in 2008/9 6,038 12,906Forecast amount of reduction in operating costs

1,140 1,140

Net running costs 4,898 11,766 Net output estimated (kWh) 27,720 64,796 Average cost per kWh $0.177 $0.182



Appendix 5 - Assessment of investment proposal Northern Division EGC $m $m $m $m Non-current assets 5,751 15,837 Income generated 5,043 13,200 Controllable costs 5,760 12,906 Gross Surplus /Deficit -717 294 RoI -12.5% 1.86% i.e. -$717m/$5,751 $294m/$15,837m $m Project (Northern Division perspective): Fuel and staff cost reduction ($135m + $180m depreciation) 315Cost of Capital (6% * $1,800m) 108Residual Income 207 RoI = $315m/$1,800m 17.5% $m Project (EGC perspective): Fuel and staff cost reduction ($315m - $180m depreciation) 135Cost of Capital (6% * $1,800m) 108Residual Income 27 RoI at end of year 1 = $135m/($1,800m - $180m) 8.33%



Answer to Question 2 Note: Students are expected to produce the slides in the form shown below – whether the exam is taken on paper or using a computer. Students sitting the exam on computer are not expected to use PowerPoint. Slide 1: Case for undertaking investment in power stations N1 and N2:

Essential that Northern Division is awarded management and operation of wind turbine programme;

N1 and N2 will be required as supplementary power generators if Northern Division awarded wind power turbine programme;

Carrying out investment will help to persuade Minister to award wind power programme to Northern Division;

Investment proposal in power stations N1 and N2 demonstrates Northern Division’s (and EGC’s) commitment to reducing harmful emissions, thus addressing a target of Minister of Energy.

Slide 2: Financial justification for investment in power stations N1 and N2:

Return on Investment in 2008/9 for Northern Division -12.5%, EGC 1.86%; Northern Division must apply EGC limits on capital investment and cannot therefore be

regarded as an investment centre for this particular investment; RoI of investment proposal for N1 and N2 = 17.5%; Residual Income of investment proposal for N1 and N2 = $207 million; RoI higher both for EGC and Northern Division after the investment proposal

implemented, therefore providing goal congruence.

The Chartered Institute of Management Accountants 2009

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Answers Specimen Exam Paper T4 Part B Case Study Nov09 · CIMA 2010 Chartered Management Accounting ... 3.0 Strategic Analysis and Position Audit 4.0 Review and prioritisation