Exercise $19-28($Algo$)$ Economic Profit and Employee Productivity; Service Industries $[$LO $19-2,19-3]$

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 people$-$intensive 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 $$100$ million in operating profit,

has $$1$ billion in investment, and uses a cost of capital rate of $5\%,$ so the capital charge is $$50$ million and the economic profit is $$50$

million. Relevant calculations are contained in Part $1$ of the following schedule:

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

$$400,000=$$$100,000+$$$300,000$

Employee productivity can be determined by calculating OPBP less capital charge, per employee. For this example, because there are

$10,000$ employees, OPBP is $$40,000$ per employee and the capital charge is $$5,000$ per employee so that productivity is $$35,000$ per

employee. The next step is to determine personnel cost per employee, $$30,000,$ and subtract that from employee productivity to

obtain economic profit per employee, $$5,000($i$.$e$.$ $$35,000-$$$30,000).$ Total economic profit for all employees is thus $$5,000$

$10,000,$ or $$50$ 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 people$-$oriented service industries.

Required:

Use the above approach and assume a chain of residential care facilities employs $10,000$ people, has a cost of capital of $6\%,$ and has

the following information $(000$s$)$:

Determine the productivity per employee, personnel costs per employee, and economic profit per employee. $($Enter your answers in

thousands.$)$