Question
XYZl PLC operates branches in city a, city b and city c. city a was the companys first, opened in 1999. city b Branch opened
XYZl PLC operates branches in city a, city b and city c. city a was the companys first, opened in 1999. city b Branch opened in 2005, andcity c opened in 2007. xyx has previously evaluated branches based on return on investment (ROI) and then residual income (RI). Carol Mays, the xyz Group manager is concerned that the focus on annual ROI could have an adverse long-run effect on the branches and the group's performance, in particular, it might cause managers to ignore emerging threats and opportunities. However, the company is considering changing to an economic value added (EVA) approach. All branches are assumed to face similar risks. Data for 2019 follow:
| city a | city b | city c | Total |
Revenues | $4,100,000 | $4,380,000 | $3,230,000 | $11,710,000 |
Variable costs | 1,600,000 | 1,630,000 | 955,000 | 4,185,000 |
Fixed costs | 1,280,000 | 1,560,000 | 980,000 | 3,820,000 |
Operating income | 1,220,000 | 1,190,000 | 1,295,000 | 3,705,000 |
Interest costs on long-term debt at 8% | 368,000 | 416,000 | 440,000 | 1,224,000 |
Income before taxes at 35% | 852,000 | 774,000 | 855,000 | 2,481,000 |
Net income | 553,800 | 503,100 | 555,750 | 1,612,650 |
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Net book value at 2019 year-end: |
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Current assets | 1,280,000 | 850,000 | 600,000 | 2,730,000 |
Long-term assets | 4,875,000 | 5,462,000 | 6,835,000 | 17,172,000 |
Total assets | 6,155,000 | 6,312,000 | 7,435,000 | 19,902,000 |
Current liabilities | 330,000 | 265,000 | 84,000 | 679,000 |
Long-term debt | 4,600,000 | 5,200,000 | 5,500,000 | 15,300,000 |
Stockholders equity | 1,225,000 | 847,000 | 1,815,000 | 3,923,000 |
Total liabilities and stockholders equity | 6,155,000 | 6,312,000 | 7,435,000 | 19,902,000 |
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Market value of debt | 4,750,000 | 5,350,000 | 5,800,000 | 15,900,000 |
Market value of equity | 2,500,000 | 2,750,000 | 2,650,000 | 7,900,000 |
Cost of equity capital |
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| 13% |
Required rate of return |
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| 12% |
Accumulated depreciation on long-term assets | 2,200,000 | 1,510,000 | 220,000 |
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- Use the DuPont method of profitability analysis to evaluate the performance of the three hotel branches for the year 2019. Use 2019 total assets as the investment base. Show your calculations and comment on the results.
- Comment on the potential strengths and weaknesses of using the DuPont method of profitability for measuring branch performance at Coral Group. What factors affecting ROI does the DuPont method of profitability analysis highlights?
- Calculate residual income (RI) for each of the hotel branches using operating income as a measure of income and total assets minus current liabilities as the measure of investment.
- david alex, the city c branch manager, argues that city b and a branches have loaded up on lot of short-term debt to boost their RI. Calculate an alternative RI for city a branch only that is not sensitive to the amount of short-term debt taken on by the branch. Comment on the results.
- Refer back to the original data. Calculate the WACC for xyzs branches
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