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A paper published in the Harvard Business Review points out a new way to calculate economic profit that could be more appropriate for service firms
A paper published in the Harvard Business Review points out a new way to calculate economic profit that could be more appropriate for service firms and other peopleintensive companies. Instead of focusing on investment and return on investment, the focus is on employee productivity, in terms of both generating revenues and reducing costs.
The approach is to first determine economic profit in the conventional way, except that we ignore taxes, so that economic profit is before tax, as follows:
Economic profit Operating profit Capital charge
Assume the following information for a hotel chain that wishes to adopt the new method. The firm has $ million in operating profit, has $ billion in investment, and uses a cost of capital rate of so the capital charge is $ million and the economic profit is $ million. Relevant calculations are contained in Part of the following schedule:
Part : Economic Profit in thousands, except cost of capital rate
Revenue $
Operating costs:
Personnel costs
Other costs
Operating profit $
Operating profit before personnel costs OPBP $
Investment capital $
Cost of capital, rate
Capital charge $
Economic profit Operating profit Capital charge $
Part : Economic Profit Calculated Using Employee Productivity
Number of employees
Employee productivity:
Operating profit before personnel cost per employee $ $
Capital charge per employee $
Employee productivity $
Less personnel cost per employee $
Economic profit per employee Productivity Cost $
Total economic profit, all employees $
Note: All numbers in thousands except for number of employees
The next step is to decompose economic profit using employee productivity. To do this, we first determine operating profit before personnel costs OPBP:
OPBP Operating profit Personnel costs
$ $ $
Employee productivity can be determined by calculating OPBP less capital charge, per employee. For this example, because there are employees, OPBP is $ per employee and the capital charge is $ per employee so that productivity is $ per employee. The next step is to determine personnel cost per employee, $ and subtract that from employee productivity to obtain economic profit per employee, $ie $ $ Total economic profit for all employees is thus $times or $ million, the same amount as determined in the conventional way. The value of the decomposition of economic profit into employee productivity and personnel costs per employee is that it provides measures that the hotel chain can benchmark to other hotel chains. It also provides a direct measure of the profit that is being generated per employee relative to the average personnel cost for each employee. Measures of revenue per employee and personnel cost per employee are widely used in the hospital, health and human services, and other peopleoriented service industries.
Required:
Use the above approach and assume a chain of residential care facilities employs people, has a cost of capital of and has the following information s:
Revenue $
Operating costs
Personnel costs
Other costs
Operating profit $
Investment $
Determine the productivity per employee, personnel costs per employee, and economic profit per employee. Enter your answers in thousands.
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