Jaslyn Toh is the founder and CEO of Express Health, a company that runs various successful beauty and slimming centres in Southeast Asia. The company operates three slimming salons in different parts of Singapore. Jaslyn personally selects and hires the salon managers and believes in delegating as much authority to her staff as possible so as to motivate them to perform well. The salon managers are given full autonomy in managing the daily operations of each salon. At the end of each year the three salon managers are evaluated and bonuses are awarded when the current year's ROI of the salon is higher than that of the previous year. If there is no improvement shown in the ROI, no bonuses are paid and the salon manager must provide Jaslyn with good justifications for not exceeding the previous year's ROI. In 2017, the company as a whole achieved an ROI of 13%. A similar ROI has been projected for 2018. Financial data for 2017 for the three salons in Singapore are listed below. Salon West $160,000 $60,000 $100,000 Salon Central $500,000 $200,000 $300,000 Salon East $360,000 $150,000 $210,000 Revenue Less: Variable expenses Contribution margin Less: Fixed expenses Advertising* Depreciation of salon equipment Salon manager salary Rent* Headquarter administrative cost Total fixed expenses Net operating income (loss) * Traceable $22,000 $20,000 $25,200 $24,000 $28,000 $119.200 ($19,200) $61,400 $40,000 $27,600 $36,000 $100,000 $265,000 $35,000 $16,600 $35,000 $24,000 $30,000 $72,000 $177,600 $32,400 $200,000 $200,000 $225,000 Operating assets** ** Non-current assets are based on net book value Required (All workings should be detailed and clearly presented. Each of the following is an independent question, always refer to the original data unless otherwise instructed.) (a) Compute ROI for 2017 for each salon using the expanded formula that includes both the margin and turnover based on net operating income and net operating assets. Round all answers to two decimal places. (6 marks) (b) Refer to (a). Comment on the relative performance of each salon in 2017 by analyzing the margin and turnover. (6 marks) Jaslyn was not pleased with Salon West's performance. She exclaimed "I just don't understand why this salon is making a loss when the other two salons are making healthy profits. It must be the poor location as it is the only salon situated in a HDB block and not in a mall. I think the best thing is to close this salon and avoid incurring another $19,000 loss this year". Jaslyn asked you, her company's intern from the Nanyang Business School, to work out some numbers to help her to decide whether to close Salon West. You did a detailed analysis of Salon West's financial data and interviewed the salon manager for additional information about its operations. With some ingenuity, you managed to round up the following pertinent information. The advertising fees are payable on a monthly basis and the contract allows for cancellation without penalty at short notice. The three-year rent contract is cancellable at any time but the penalty clause requires the tenant to pay 30% of the annual rent upon lease termination. In the event that Salon West is closed, Jaslyn would offer a redundancy payment of $3,000 to the salon manager as a gesture of goodwill. Headquarter administrative costs are allocated to all salons and would not be affected by the closure of any particular salon. Would you advise Jaslyn to close Salon West? Why or why not? Support your recommendation with clear and detailed calculations. (7 marks) Chin Kia Su is the salon manager of Salon Central. He is very proud that Salon Central has generated the highest operating income in 2017 and is determined to work harder to improve his performance this year. Chin is considering whether to purchase a new innovative slimming equipment, the Super Slimmer, from Korea. The Super Slimmer uses thermal energy to break down cellulite very quickly and promises excellent slimming results. Chin believes that this equipment would be very popular with his salon's largely middle-aged clientele and would definitely boost revenue and profit in 2018. Chin's only concern regarding the acquisition of the Super Slimmer is that Salon Central's ROI for 2018 must show an improvement over its ROI for 2017. Before making the decision to buy the Super Slimmer, Chin decided to work out some financial forecasts for 2018, as shown below. Question 2 (continued) (1) The cost of the Super Slimmer is $80,000 with a residual value of $5,000 at the end of its useful life of 5 years. The new equipment, like all other salon equipment, will be depreciated on a straight-line basis. The 'net book value of non-current operating assets has been used in the computation of ROls, in line with corporate policy. Revenue is forecasted to increase by 11.25% in 2018 due to the purchase of Super Slimmer. Variable expenses are forecasted to remain at 40% of revenue. The depreciation expense (excluding the Super Slimmer) is forecasted to remain at $40,000 for the current year, with no changes in the composition of existing operating assets Headquarter administrative cost is forecasted to increase by 20% over allocation in 2017. All other expenses are forecasted to remain the same as in 2017. (vi) Compute the forecasted operating income and the ROI of Salon Central in 2018 based on all available information. Do you think Chin would be in favour of acquiring the Super Slimmer? Why or why not? Support your view with clear and detailed calculations. (13 marks) (e) Refer to Part (d). Do you think that Jaslyn, being the CEO of the company, would view the acquisition of the Super Slimmer the same way as Chin? Why or Why not? Support your view with clear and concise arguments. (5 marks) (f) Assume that the company has decided to use the Residual Income method to compute salon performances for 2018. Based on the information in Part (d), what is the minimum required rate of return that will motivate Chin to acquire the Super Slimmer? (3 marks) In companies such as Express Health, the ROI of a salon generally increases over time. Explain why this occurs and discuss a potential undesirable investing behaviour it can induce in salon managers. How can this undesirable behaviour be avoided? Provide an example to support your discussion. (8 marks) (TOTAL: 48 marks)