^{Renewal Resorts, Inc. operates health spas in Key West, Florida; Phoenix, Arizona; and Carmel, California. The Key West spa was the companys first and opened in 1996. The Phoenix spa opened in 2006, and the Carmel spa opened in 2015. Renewal Resorts currently evaluates divisional managers based on return on investment (ROI), but the company is considering changing their performance evaluation system to an EVA approach. Data for 2019 are as follows: Table 1}

^{Interest costs on long-term debt are 7% per year. Renewal Resorts pays a 20% tax rate on income. Renewal believes that advertising provides benefits over 2 years and therefore for EVA purposes should be amortized on a straight-line basis over a 2-year useful life (beginning with the year of the expenditure). Advertising for 2019 is shown in the table above. Advertising for 2018 for the Key West, Phoenix, and Carmel spas was $550,000, $775,000, and $450,000, respectively.}

^{1.) For each of the spas, calculate 2019 ROI using operating income as the numerator measure of income and total assets as the denominator measure of investment.}

^{2.) Suppose that Renewal Resorts is considering adding new saunas from Finland. For each spa, the new saunas would cost $425,000 and would be expected to result in an incremental increase in operating income of $50,000. a) What is the incremental ROI and what effect would the addition of the saunas at the Key West spa have on 2019 ROI for Key West? If performance evaluation is based on ROI, would the Key West manager have an incentive to accept or reject this project? Explain your answer. b) Would the Phoenix spa manager have an incentive to accept or reject addition of saunas? Would the Carmel spa manager? Explain.}

^{3.) a) Assume that Renewal did not add the saunas in question 2. Calculate 2019 EVA for each of the spas. b) The board of directors is struggling to decide how to set the parameters of a performance evaluation system based on EVA. In the interest of fairness, they are considering setting the target EVA for all three spas at the same level, $50,000. Write a paragraph to advise the board on the proposed target EVA.}

^{4.) Refer back to the information and assumptions in question 2. For each spa, explain whether the manager has an incentive to add the new saunas if they are evaluated based on EVA instead of ROI. Assume that the managers receive incentive compensation equal to 10% of EVA.}

^{5.) Would you recommend that Renewal Resorts change their performance evaluation system to focus on EVA or continue to focus on ROI for evaluating the performance of the three spas? Explain.}

Revenues Leasing and other costs Advertising costs Operating income Interest and taxes Net income Key West Spa $ 3,900,000 2,300,000 575,000 1,025,000 462,600 562,400 Phoenix Spa $ 4,150,000 2,830,000 305,000 1,015,000 494,200 520.800 Carmel Spa $ 3,130,000 1,655,000 830,000 645,000 437,000 208,000 Total $ 11,180,000 6,785,000 1,710,000 2,685,000 1,393,800 1,291,200 $ $ $ Net book value at 2019 year-end: Current assets Long-term assets Total assets Current liabilities Long-term debt Stockholders' equity Total liabilities and equity Weighted average cost of capital (WACC) Accumulated depreciation 1,280,000 5,375,000 6,655,000 330,000 4,600,000 1,725,000 6,655,000 850,000 5,862,000 6,712,poo 265,000 5,200,000 1,247,000 6,712,000 600,000 6,535,000 7,135,000 84,000 5,500,000 1,551,000 7,135,000 2,730,000 17,772,000 20,502,000 679,000 15,300,000 4,523,000 20,502,000 9% 2,220,000 1,510,000 220,000