Reference no: EM132669036

The Chilled Leisure Company (CLC) has decentralised the operation decision-making of its divisional units. The Chief Operating Manager for each of these business units is given a great deal of freedom in their decision making however, the company offers bonuses of up to 100% of their annual fixed salary for achieving high profit returns and at the same time, carefully managing the amount of capital they use in their divisions.
CLC uses traditional performance measures such as Return on Investment (ROI) or simple Profit measures. CLC's Chief Executive and Chairman believe profit-based measures are still the most important measure because that is what shareholders want.

The projections for 2019 for CLC's Hotels and Casino Resort Division (CRD) are as follows

Sales: $10 000 000
Profit: 24%
Average Invested Capital $12 000 000

Required:

Problem a) Calculate what the Return on Investment (ROI) for the Casino Resort Division will be for 2019?

The Board of CLC and the CEO have decided on a set of strategies with the goal of expanding their offering to regular guests by setting up a loyalty program. The extra costs of this loyalty program would include an additional $8,000,000 in software and setup (capital) costs and it is expected that this would generate an additional $5,000,000 in sales however profit margin (after running costs) would initially fall to 22%.

Problem b) Calculate the new ROI if this new program was introduced.

Problem c) Discuss how the manager may feel about this new innovation if the costs affected the ROI and therefore the bonus payable

Problem d) If CLC went ahead with the new program and used Economic Value Add (EVA) to also balance and measure performance, would the manager be more or less in favour of the proposal?

Assume the trade creditors and 'free' credit would be $600,000, the tax rate is 30% and the Weighted Average Cost of Capital (WACC) was 11%. (Show calculations and give reasons for your answer.)

Problem e) If the manager accepted the proposed reduced margin of 22% but wanted to negotiate with the CEO about the extent of the Loyalty Program (i.e. minimise proposed investment cost) to maintain an ROI of say 19%, what is the maximum amount of (average) invested capital that could be made and still achieve this goal?

Problem f) If the CEO agreed with the manager's new investment target in e) calculate the EVA with these new amounts, using the same trade creditor, tax rate and WACC as shown in d) above.