Textbook Assignments - Week 5.xlsx

Textbook Assignments - Week 5.xlsx - Exercise 25.4 Sapsora...

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Unformatted text preview: Exercise 25.4 Sapsora Company uses ROI to measure the performance of its operating divisions and to reward division managers. A summary of th Total assets Current liabilities After-tax operating income ROI Question A: Which division is more profitable? Answer to Question A: Because the ROI is higher Division A would be more profitable Question B: Would EVA more clarly show the relative contribution of the two divisions to the company as a whole? Show the computation Formula: EVA = After-tax Operating Income - (Division's total assets - Division's Current liabilities) x Weighted Average Cost of Capital) Answer to Question B: Division A EVA = $1,000,000 - ($6,000,000 - $500,000) x 12% Division A EVA = $340,000 Division B EVA = $1,180,000 - ($8,750,000 - $1,750,000) x 12% Division B EVA = $340,000 Question C: Suppose the manager of Division A was offered a one-year project that would increase his investment base by $250,000 and show a profit of $37,500. Would the manager choose to invest in the new project? Answer to Question C: If the manager were to chose to invest in Division A then the EVA would increase, so yes the manager would invest in Division A. Exercise 25.5 An investment center in Shellforth Corporation was asked to identify three proposals for its capital budget. Detailes of those proposals Capital Required Annual operating return Shellforth uses residual income to evaluate all capital budgeting projects. Its minimum required return is 12% Question A: Assume you are the investment center manager. Which project do you prefer? Why? Answer for Question A: Because Division B has the highest residual income Division B would be the better investment Capital Required Annual operating return Less: Return on Capital (12%) Residual Income Question B: Assume your investment center’s current ROI is 18 percent and that the president of Shellforth is thinking about using ROI for the inve Why? Answer for Question B: Since the residual income is still the highest with Project B. I would stay with Project B Exercise 25.6 Jennifer Baskiter is president and CEO of Plants& More.com , an Internet company that sells plants and flowers. The success of her s and the other focuses on business-to-business sales to hotels, restaurants, and other firms that want plants and flowers for their busin as a compensation consultant. What issues or concerns would you raise regarding the use of ROI for evaluating the divisions and thei Answer for 25.6 I would caution Jennifer that while there are advantages to using ROI to evaluate divisions and managers within her company that ofte be good for the entire company would be passed over. Also, managers may invest funds in existing projects that have a high ROI but division and ignores the long term profitability. Another risk is that managers can start to cut spending on trainings for employees, prod she needs to include other parameters to evaluate managers on, and not focus only on ROI Exercise 25.7 You are the manager of the Midwest Region, a 27-restaurant division that is part of the chain “Bites and Bits.” The restaurants offer cas Olive Garden and Outback Steakhouse . You receive an annual cash bonus of 5 percent of sales when residual income in your region 15 percent. You are using a similar performance evaluation plan to reward each of the managers in your 27 restaurants. You are concerned that important performance variables are being overlooked. For example, you have heard complaints from other re good chef is very difficult. At an upcoming planning meeting for all regional directors, the agenda includes considering the business pe propose to remedy the problems? Answer for Exercise 25.7 With no incentive to maintain quality and no incentive making employees want to stay there needs to be a lot of thought put into how to staff working for tips provide servers with a salary. Majority of servers try to get customers to increase their bill, in order to increase the sellers during a time period. By providing the servers with a salary this will cut down on employee turnover because they are being pro hire and train new staff. One of the biggest reason food quality is low and good chefs are hard to retain is because a big fear in the kit profit sharing to the kitchen staff. By sharing the profits with them it encourages them to reduce waste, maintain high quality standards performance evaluations, and years with the company. In an organization it is not just the managers that need incentive to boost profit that they are a valueable part of the organization and that they are making a contribution. Exercise 26.8 Pack and Carry is debating whether to invest in new equipment to manufacture a line of high-quality luggage. The new equipment wou equipment are as follows: Revenue from sales of new luggage Expenses other than depreciation Depreciation (straight-line basis) Increase in net income from the new line All revenue from the new luggage line and all expenses (except depreciation) will be received or paid in cash in the same period as rec luggage line: Answer Annual cash flows Payback period Return on average investment Total present value of the expected future annual cash inflows, discout an an annual rate of 10% Net present value of the proposed investment discounted at 10% Exercise 26.9 The division managers of Chester Construction Corporation submit capital investment proposals each year for evaluation at the corpor budget. Thus, each proposal is first ranked by its estimated net present value as a primary screening criterion. Jeff Hensel, the manag thereby inflates their net present values. He does so because, in his words, “Everybody else is doing it.” Question A: Assume that all the division managers do overstate cash flow projections in their proposals. What would you do if you were recently p Answer for Question A If I were the manager I would overstate my cash flow projections so the division under my responsibility does not suffer. I would discus the realistic financial needs of the divisions. Then provide that solution to executve management to see if the issue can be addressed. Question B: What controls might be implemented to discourage the routine overstatement of capital budgeting estimates by the division managers? Answer for Question B By implementing internal control systems such as executive management signing off on large capital investments, having the finance d monitoring the actual costs of a project compared to proposed costs, and by performing random audits will help control the inflation of Exercise 26.10 EnterTech has noticed a significant decrease in the profitability of its line of portable CD players. The production manager believes tha The issue raised, therefore, is whether EnterTech should (1) buy new equipment at a cost of $120,000 or (2) continue using its presen five-year time horizon. EnterTech estimates that both the new equipment and the present equipment will have a remaining useful life o cash savings in manufacturing costs of $34,000, before taking into consideration depreciation and taxes. However, management does decision rests entirely on the magnitude of the potential cost savings. The old equipment has a book value of $100,000. However, it ca percent and uses straight-line depreciation for tax purposes. The company requires a minimum return of 12 percent on all investments Question A: Compute the net present value of the new machine using the tables in Exhibits 26–3 and 26–4. Answer for Question A Cost savings Depreciation Gross Profit Tax 40% Net Profit Plus Depreciation Annual cash flow Cost of new equipment Less: Replacement value Less: Tax savings Net Cost Year 0 1 2 3 4 5 Net Present Value = $11,305 Question B: What nonfinancial factors should EnterTech consider? Answer for Question B Will quality suffer? Will the output of the machine increase? Are there any environmental concerns? Question C: If the manager of EnterTech is uncertain about the accuracy of the cost savings estimate, what actions could be taken to double-check the estimate? Answer for Question C Review all the cost savings and see if there are any inaccuracies. Calculate the net present value and under the best condition and the worst conditions. Communicating with other division managers to ensure that their calculations are accurate and identify any inconsistencies within the cost savings from the divisions. sions and to reward division managers. A summary of the annual reports from two divisions is shown below. The company's weighted-average co Division A $6,000,000 $500,000 $1,000,000 25% he company as a whole? Show the computation n's Current liabilities) x Weighted Average Cost of Capital) oposals for its capital budget. Detailes of those proposals are: minimum required return is 12% Capital Budget Proposals A $80,000 $24,000 Capital Budget Proposals A $80,000 $24,000 80,000 x .12 = $9,600 $14,400 dent of Shellforth is thinking about using ROI for the investment center’s evaluation. Would your preferences for the projects listed above change? mpany that sells plants and flowers. The success of her startup Internet company has motivated her to expand and create two divisions. One divisio nd other firms that want plants and flowers for their businesses. She is considering using return on investment as a means of evaluating her divisio arding the use of ROI for evaluating the divisions and their managers? uate divisions and managers within her company that often division managers will choose capital investments that will produce a high ROI for their d nvest funds in existing projects that have a high ROI but will not bring anything to the company as a whole. I would also advise her that ROI only fo can start to cut spending on trainings for employees, product development, and marketing just to improve the division's ROI. While using ROI does us only on ROI art of the chain “Bites and Bits.” The restaurants offer casual dining and competes with such chains in your region as of 5 percent of sales when residual income in your region exceeds the required minimum return on invested capital of ch of the managers in your 27 restaurants. d. For example, you have heard complaints from other regions and in your own region that the quality of the food is bad, it is difficult to retain servin rectors, the agenda includes considering the business performance evaluation and compensation plan. What could you say about the current com t to stay there needs to be a lot of thought put into how to make employees remain loyal to "Bites and Bits" and care about the quality of the produc et customers to increase their bill, in order to increase their tips, providing a salary for the servers with an incentive to servers who maintain a consi t down on employee turnover because they are being provided with a steady income. Restaurants will start to see an increase in savings becase th od chefs are hard to retain is because a big fear in the kitchen is losing your job. So kitchen staff just keeps pushing the food out without a second es them to reduce waste, maintain high quality standards, and work harder to create larger profits for the company. Provide managers with bonuse s not just the managers that need incentive to boost profits, maintain quality, work efficiently, and remain loyal. The entire restaurant staff from the d contribution. re a line of high-quality luggage. The new equipment would cost $1,728,125, with an estimated five-year life and no salvage value. The estimated $306,250 $345,625 will be received or paid in cash in the same period as recognized for accounting purposes. You are to compute the following for the investment in Formula Annual cash flow = Net Income + Depreciation Payback period = Invest amnt ÷ Annual Cash Flow Average Investment = (Original cost + Salvage Value) ÷ 2 Return on average investment = Average estimated net income ÷ Average Investment Present value = Annual cash flow ÷ (1 + .10)5th power Net present value = Present value of cash inflows - Outflow vestment proposals each year for evaluation at the corporate level. Typically, the total dollar amount requested by the divisional managers far excee as a primary screening criterion. Jeff Hensel, the manager of Chester’s commercial construction division, often overstates the projected cash flow Everybody else is doing it.” heir proposals. What would you do if you were recently promoted to division manager and had to compete for funding under these circumstances? on under my responsibility does not suffer. I would discuss the issue with the other division managers and see if we could find a solution to address ecutve management to see if the issue can be addressed. of capital budgeting estimates by the division managers? ning off on large capital investments, having the finance department analyze and audits on the accuracy of estimates from division managers, performing random audits will help control the inflation of capital budget estimations ortable CD players. The production manager believes that the source of the trouble is old, inefficient equipment used to manufacture the product. ent at a cost of $120,000 or (2) continue using its present equipment. It is unlikely that demand for these portable CD players will extend beyond a the present equipment will have a remaining useful life of five years and no salvage value. The new equipment is expected to produce annual tion depreciation and taxes. However, management does not believe that the use of new equipment will have any effect on sales volume. Thus, its d equipment has a book value of $100,000. However, it can be sold for only $20,000 if it is replaced. EnterTech has an average tax rate of 40 quires a minimum return of 12 percent on all investments in plant assets s 26–3 and 26–4. $34,000 -$4,000 $30,000 $12,000 $18,000 $4,000 $22,000 Amount $120,000 -$20,000 -$32,000 $68,000 Cash Flow -$68,000 $22,000 $22,000 $22,000 $22,000 $22,000 sions is shown below. The company's weighted-average cost of capital is 12% Division B $8,750,000 $1,750,000 $1,180,000 14% al Budget Proposals B C $50,000 $16,000 $150,000 $15,000 al Budget Proposals B C $50,000 $16,000 50,000 x .12 = $6,000 $10,000 $150,000 $15,000 150,000 x .12 = $18,000 -$3,000 ould your preferences for the projects listed above change? motivated her to expand and create two divisions. One division focuses on sales to the general public ng return on investment as a means of evaluating her divisions and their managers. She has hired you se capital investments that will produce a high ROI for their division and other investments that would ompany as a whole. I would also advise her that ROI only focuses on the short term profitability of a ing just to improve the division's ROI. While using ROI does have benefits I would advise Jennifer that h such chains in your region as m return on invested capital of that the quality of the food is bad, it is difficult to retain serving staff in the restaurants, and finding a mpensation plan. What could you say about the current compensation plan and what would you al to "Bites and Bits" and care about the quality of the product that they produce. Instead of the serving he servers with an incentive to servers who maintain a consistent high level of service and are top Restaurants will start to see an increase in savings becase there will no longer be a constant need to chen staff just keeps pushing the food out without a second thought of quality or efficiency. Provide rger profits for the company. Provide managers with bonuses based on their annual sales, their ently, and remain loyal. The entire restaurant staff from the dishwasher to the manager needs to feel stimated five-year life and no salvage value. The estimated annual operating results with the new $800,000 $651,875 $148,125 oses. You are to compute the following for the investment in the new equipment to produce the new Answer $148,125 + $345,625 = $493,750 $1,728,125 ÷ $493,750 = 3.5 Years ($1,728,125+0) ÷ 2 = $86,4062 $148,125 ÷ $86,4062 = .17 (17%) 493,750 ÷ (1 + .10)5th power = $1,871,701 $1,871,701 - 1,728,125 = $143,576 ollar amount requested by the divisional managers far exceeds the company’s capital investment onstruction division, often overstates the projected cash flows associated with his proposals, and and had to compete for funding under these circumstances? sion managers and see if we could find a solution to address s on the accuracy of estimates from division managers, old, inefficient equipment used to manufacture the product. demand for these portable CD players will extend beyond a lue. The new equipment is expected to produce annual w equipment will have any effect on sales volume. Thus, its t is replaced. EnterTech has an average tax rate of 40 DF at 12% 1.000 0.893 0.797 0.712 0.636 0.567 PV -$68,000 $19,643 $17,538 $15,659 $13,981 $12,483 ...
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