The Empire Hotel is a full-service hotel in a large city. Empire is organized in

Question

The Empire Hotel is a full-service hotel in a large city. Empire is organized into three departments that are treated as investment centers. Budget information for the coming year for these three departments is shown as follows. The managers of each of the departments are evaluated and bonuses are awarded each year based on ROl Empire Hotel Hotel Rooms $ 8,472,000 $ 10,000,000 8,756,000 $ 1,244,000 Health Spa $ 1,062,000 $ 600,000 405,000 195,000 Restaurants $ 4,531,000 $ 2,000,000 Average investment Sales revenue Operating expenses Operating earnings 1,015,000 $985,000 Required a. Compute the ROl for each department. Use the DuPont method to analyze the return on sales and capital turnover Assume the Health Spa is considering installing new exercise equipment. Upon investigating, the manager of the division finds that the equipment would cost $40,000 and that operating earnings would increase by $8,000 per year as a result of the new equipment. b-1. What would be the ROl of investment in the new exercise equipment and Health Spa? b-2. Would the manager of the Health Spa be motivated to undertake such an investment? c-1. Compute the residual income for each department if the minimum required return for the Empire Hotel is 17 percent. c-2. What would be the impact of the investment on the Health Spa's residual income?

Explanation / Answer

Before Installing Rooms Resturent SPA Total Average Investment        84,72,000        45,31,000        10,62,000 1,40,65,000 Sales Revenue     1,00,00,000        20,00,000           6,00,000 1,26,00,000 Operating Expenses        87,56,000        10,15,000           4,05,000 1,01,76,000 Operating Earning        12,44,000           9,85,000           1,95,000      24,24,000 Assets Turnover 118.04% 44.14% 56.50% 89.58% Margin 12.44% 49.25% 32.50% 19.24% ROI 14.68% 21.74% 18.36% 17.23% After Installing Rooms Resturent SPA Total Average Investment        84,72,000        45,31,000        11,02,000 1,41,05,000 Operating Earning        12,44,000           9,85,000           2,03,000      24,32,000 ROI 14.68% 21.74% 18.42% 17.24% b-1 ROI of the new exercise equipment Add.SPA Average Investment              40,000 Operating Earning                 8,000 ROI 20.00% b-2 Yes, because SPA ROI is 18.36% & Total ROI is 17.24% however in this case ROI is 20% so it must be accepted C-1 compute the residual income of each department if the minimum required return for empire hotel is 17 percent Before After Rooms Resturent SPA SPA Average Investment        84,72,000        45,31,000        10,62,000      11,02,000 Required Return 17%        14,40,240           7,70,270           1,80,540        1,87,340 Operating Earning        12,44,000           9,85,000           1,95,000        2,03,000 Residual Income         -1,96,240           2,14,730              14,460            15,660 C-2 Before After Difference SPA SPA Average Investment        10,62,000        11,02,000              40,000 Required Return 17%           1,80,540           1,87,340                 6,800 Operating Earning           1,95,000           2,03,000                 8,000 Residual Income              14,460              15,660                 1,200

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