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An Economic Framework for Assessing the Financial Performance of Government Trading Enterprises

Performance monitoring report

This report was released in June 1996. This paper was prepared to promote an understanding of the concepts associated with the measurement of Economic Rate of Return of Return (ERR) for Government Trading Enterprises (GTEs) across the Commonwealth, States and Territories.

Although, as is the case with all measurement, there are some limitations with the use of economic measures, the framework described in this paper provides a consistent approach to the development and application of appropriate rate of return measures and targets.

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Contents


Preliminaries
Cover, Copyright, Contents, Preface, Abbreviations, Overview

1   Background
1.1   An adequate return
1.2   Current measures of return
1.3   Objectives of the paper

2   Market-based performance assessment
2.1   Performance assessment in competitive capital markets
      2.1.1   Cost of capital
      2.1.2   Market-based measures of performance
2.2   Accounting-based performance framework
      2.2.1   Accounting rate of return
      2.2.2   Accounting targets
2.3   Benefits of the suggested methodologies

3   Cost of capital targets
3.1   Risk-return trade off
      3.1.1   Diversification
      3.1.2   Unique risk and GTEs
      3.1.3   Business unit targets
3.2   Target-setting methodology
      3.2.1   Weighted average cost of capital
      3.2.2   Capital asset pricing model
      3.2.3   Return-on-assets CAPM
3.3   Defining a GTE's cost of capital
      3.3.1   Nominal and real targets
      3.3.2   Pre- and post- financing targets
      3.3.3   Determining a GTE's WACC
      3.3.4   Income tax and cost of capital targets
      3.3.5   Summary

4   Measuring the financial performance of a GTE
4.1   ERR measurement
      4.1.1   Cash component of economic income
      4.1.2   Capital component of economic income
      4.1.3   Capital base
4.2   Other information requirements of the formula
      4.2.1   Asset valuation
      4.2.2   Matching economic income and the asset base
4.3   Reconciling measured ERR with the target
4.4   Value-based management

5   The application of a cost of capital target and financial performance measure to selected GTEs
5.1   Target setting
      5.1.1   Capital structure
      5.1.2   Cost of debt
      5.1.3   Cost of equity
      5.1.4   Calculating a cost of capital target
5.2   Performance measurement
5.3   ERR performance and reconciliation with an adjusted cost of capital target
5.4   Performance assessment

6   Assessing a GTE's financial performance
6.1   Factors affecting a GTE's measured performance
6.2   Other financial performance indicators
6.3   Interaction of pricing and ERR performance
6.4   Adjusting to a new performance regime

APPENDICES

A   The capital asset pricing model and the weighted average cost of capital

B   Alternative CAPM approaches to determining the required rate of return on assets

C   Estimating equity betas for GTEs

D   The deprival value approach

E   Sources of information for the calculation of ERR

F   Measuring the ERR performance of the FAC

G   Adjusting cost of capital targets and measured ERR for the FAC

H   Deriving a cost of capital target for the FAC

Bibliography

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