Subway Sandwiches operates a fast-casual sandwich chain in California. The company's first location, SFO, was opened in 2018. The Sanjose and LA locations followed suit in 2019. Operations are heavily decentralized and store managers are evaluated on their return on investment (ROI) with corporate expecting them to achieve at least a 20% ROI. (As explained below, Subway calculates ROI as the controllable margin of the store in a period divided by the total assets at the end of the period.) The company is considering changing its performance evaluation system to an EVA approach. Data for 2021 is provided below:

	Sanjose	SFO	LA	Total
Revenues	$3,683,000	$4,150,000	$3,130,000	$10,963,000
Variable Food Costs	$1,415,504	$1,611,000	$1,264,000	$4,290,504
Gross Profit	2,267,496	2,539,000	1,866,000	6,672,496
Variable Labor Costs	$991,200	$913,000	$688,600	$2,592,800
Variable Advertising (5% of Revenues)	$165,735	$186,750	$140,850	$493,335
Manager Salary	$100,000	$120,000	$132,000	$352,000
Controllable Expenses	1,256,935	1,219,750	961,450	3,438,135
Controllable Margin	1,010,561	1,319,250	904,550	3,234,361
Rent	$350,000	$380,000	$360,000	$1,090,000
General Admin	$500,350	$629,500	$323,900	$1,453,750
Corporate Overhead	$0	$0	$0	$175,000
Total Non-Controllable Expenses	850,350	1,009,500	683,900	2,718,750
Operating Profit	160,211	309,750	220,650	515,611
Interest				270,000
Taxes				49,122
Net income				196,489
Net book value at 2021 year-end:
Current assets	$970,000	$850,000	$600,000	2,420,000
Long-term assets	3,675,000	4,802,000	3,205,000	11,682,000
Total assets	4,645,000	5,652,000	3,805,000	14,102,000
Current liabilities (non-interest bearing)	330,000	265,000	184,000	779,000
Long-term debt	-	-	-	4,500,000
Stockholders' equity				8,823,000
Total liabilities and equity				14,102,000
Weighted average cost of capital (WACC)				8%

The company currently borrows at 6% per year on its long-term debt and pays a 20% tax rate on income.

Required:

1. For each of the stores, calculate 2021 ROI using controllable margin as the numerator measure of income and total assets at year-end as the denominator measure of investment.
2. During a metro-wide managers meeting, Michael Scott, the company's financial controller suggests using "current cost" accounting to calculate the ROI saying "Inflation is here, lease costs in California have gone up almost 15% from last year. We should revalue the long-term assets on the balance sheet, which mainly consists of the capitalized lease assets, to reflect what it would take in investment to operate this business if we started today". Suppose Subway Sandwiches adjusts the long-term assets (assumed to be all capitalized leases) on the balance sheet upwards by 15% as he suggests:

a) What is the new ROI for all three locations and what effect would this accounting change have on the 2021 ROI for the three stores.

b) If store manager bonuses are conditional on achieving the 20% ROI earmarked by corporate, which manager would be most strongly opposed to this change?Briefly explain.

3. a) Assume that Subway did not go along with the change suggested in Question 2.

Subwaybelieves advertising provides benefits over 4 years and therefore for EVA purposes should be amortized on a straight-line basis over a 4-year useful life (beginning with the year of the expenditure). Similarly, the organization prioritizes training and expects the benefits to persist over a 3-year useful life. Advertising and training expenses incurred in the years 2018 through 2021 are as shown below:

	2018	2019	2020	2021
GAAP Advertising Expense	$ 220,100	$ 392,500	$ 455,105	$493,335
Training Costs	$101,200	$103,540	$119,843	$129,640

Calculate 2021 EVA for Subway Sandwiches. Calculate the 2021 Income statement and Balance Sheet adjustments related to advertising and training expenses. Clearly show and label the income effect (i.e., the net adjustment to NOPAT) and the balance sheet effect (i.e., the adjustment to invested capital) in your calculations

4. Subway is considering a capital investment to upgrade the kitchen layout and install cold rooms in all three locations. The upgrades are expected to cost $840,000.The resulting annual cost savings is expected to increase operating profit by $120,000. Should Subway go ahead with the investment if performance evaluation is based on EVA? Show your analysis

5. a) The board of directors is struggling to decide how to set the parameters of a performance evaluation system based on EVA for all locations. In the interest of fairness, they are considering setting the target EVA for all three locations at the same level, $30,000. advise the board on the proposed target EVA.

b) Would you recommend that Subway Sandwiches change their performance evaluation system to focus on EVA or continue to focus on ROI for evaluating the performance of the three stores? Explain.