You are given the following information for the Arlington Company, located in Vermont: line # 1 22,000,000 19,800,000 Total revenue Total non-capital costs Capital equipment purchase price and original market value Equipment salvage value, as percent of purchase price 3 12,000,000 4 8% 5 18 Depreciable life of the capital equipment, years Annual return on capital invested in a similarly risky investment 6 8% 1. Calculate the annual accounting profit. In making this calculation, assuming that the tax laws require accountants to use a 10-year straight-line depreciation of the original purchase price net of the salvage value (e.g., a $100,000 piece of equipment with a salvage value of $10,000 would have annual depreciation of ($100,000 - $10,000)/10 = $9000). (Note: you will be using 10 years for the depreciation for the calculation of accounting profits regardless of what you are given above for the actual depreciable life of the equipment. For the calculation of economic profits, use the actual depreciable life given above.) 7 2. Calculate the economic profit using the average annual opportunity cost of the capital. See ML203's third example for guidance. (You will be using this opportunity cost instead of the depreciation described in (1). This calculation will use the depreciable life of the capital equipment given on line #5.) 8 In Moodle vou will enter the given values for lines 1-6 this is merely to check what data vou were working with it is not for credit and your answers to (1) and (2) above (for credit) The Arlington Company has five lines of business, here simply numbered 1 through 5. Each business line uses services from the company's accounting, information technology (IT), and warehousing departments. The table below gives the revenues, direct costs, and capital (e.g., the value of property, plant, and equipment) for each line of business. You are also given the variable costs from the three service departments. Fixed costs for the service departments can be ignored. All dollar figures are in millions of dollars. 4 Business # Revenue Total direct costs Capital invested 1 $15 $12 $12 2 $20 $18 $12 3 $15 $10 $12 $20 $15 $12 5 $30 $25 $22 Service division Total variable costs Accounting $2 IT $3 Warehousing $5 For each business, calculate the return on capital, but ignore the indirect costs from the three service divisions. This is calculated as (revenue - total direct costs)/capital invested. You will enter this information, to three decimal places, in Moodle. A return of 12.46 percent would be reported as 0.125. As an executive in this company you are concerned with the following: (1) the business lines have little incentive to reduce their requests for services from the three service divisions; (2) the service divisions are unable to tie their requested budgets to the value of their services; and (3) some of the businesses may have low returns on capital and should be sold off. To initially address these issues you are imposing an internal pricing system, where each of the three service divisions charge the businesses for the services provided. The expected percentage allocation of the variable costs from each service division to each business are given in the matrix below. Notice that the sum of the allocations from a service division sum to 1.0. Service division Accounting IT Warehousing Allocation share to each business from each service division 1 2 3 4 5 0.10 0.15 0.20 0.25 0.30 0.20 0.15 0.10 0.30 0.30 0.20 0.15 0.10 0.25 0.25 Use this information to allocate the service divisions' variable costs to the five businesses. Recalculate the return on capital for each of the five businesses. You will enter the revised return on capital, to three decimal places, in Moodle. Suppose that the market rate of return for similarly risky investments is 8.5 percent. If you took the approach of Goizueta at Coca-Cola, as discussed in ML204, which businesses should be sold