Chapter 11 ICE 11-1 F18 PDF

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ICE 11-1 for Danny Siciliano...

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CHAPTER 11 – IN CLASS EXAMPLE 11-1 RETURN ON INVESTMENT AND RESIDUAL INCOME Caesar’s Entertainment Corporation reported the following results from last year’s operations at the Linq Entertainment District (Linq).

(last year) This year, the company has a $120,000 investment opportunity with the following cost and revenue characteristics:

(this year’s investment opportunity) The minimum required rate of return is 15% for Caesar’s Entertainment Corporation. The GM for Linq reports to the CEO of Caesar’s.

Conceptual Questions 1) What is ROI?

Return / Investment OI / Average operating assets (beginning operating assets + ending operating assets divided by 2) ROI is a %

Land and Cash is non operating assets

2) What are the components of ROI? ROI = Margin * Turnover ROI = M * TO Margin is = OI/ Sales Turnover is = Sales/Average Operating Assets (AOA) - Essentially OI/AOA = ROI Margin = % Turnover is a number >1

o o o o

Turnover sell a lot Margin make a lot Low turnover, high margin High turnover, low margin

3) What type of responsibility center is evaluated based on ROI? -

Investment center

Quantitative Questions: 1. What is last year’s margin?

M = OI/Sales M=200,000/1,000,000 = 20%

2. What is last year’s turnover?

Turnover = Sales /AOA TO = 1,000,000/625,000 = 1.6

3. What is last year’s return on investment (ROI)? ROI= M* Turnover .2*1.6=32%

4. What is the margin related to this year’s investment opportunity? Need CM Income statement Sales 200,000 VC

80,000

Cm

120,000

FE

90,000

OI 30,000

Margin = OI/Sales Margin = 30,000/200,000 = 15%

AOA = 120,000, lol it was in the question

5. What is the turnover related to this year’s investment opportunity? TO = Sales/AOA TO= 200,000 / 120,000 = 1.67

6. What is the ROI related to this year’s investment opportunity? ROi = margin * turnover 15% * 1.67 = 25%

7. If Linq pursues the investment opportunity and otherwise performs the same as last year, what ROI will it earn this year? Last year we made 32%, this year we can make 25% The number will be between 25-32

Last year + this year = combined 200,000/625,000 + 30,000/120,000 = 32% + 25% = 30.87% no, because 25% is lower then 32%

Oi/Aoa = ROI 8. If Linq’s GM will earn a bonus only if his ROI from this year exceeds his ROI from last year, would he pursue the investment opportunity? Would the CEO of Caesars’ want him to pursue the investment opportunity? No, 25% is less then 32% but yes because 25% is higher then 15%

9. What is last year’s residual income? RI = OI – “Company Rate * AOA”(Hurdle) 200,000 – (15% * 625,000) 200,000 – 93,750 = 106,250 Positive Income we accept the project

10. What is the residual income of this year’s investment opportunity?

RI = OI – “Hurdle” 30,000 – (15%*120,000) 30,000 – 18,000 = 12,000

11. If Linq pursues the investment opportunity and otherwise performs the same as last year, what residual income will it earn this year? New projectt -

RI Last Year + RI this year = Combined 106,250 + 12,000 = $118,250

12. If Linq’s GM will earn a bonus only if his residual income from this year exceeds his residual income from last year, would he pursue the investment opportunity?

Yes, because RI on new investment is greater then 0...