1. Calculate Return on Investment (ROI) for each of the hotels based on operatin
ID: 2528151 • Letter: 1
Question
1. Calculate Return on Investment (ROI) for each of the hotels based on operating income and using total assets as the measure of investment. The manager of St. Francisco Hotel is considering adding new saunas from Finland that will cost $200,000. The saunas are expected to bring in operating income of $25,000 per year. What effect would this project have on the ROI and Residual Income (RI) of the St. Francisco Hotel? Would the St. Francisco Hotel manager accept or reject this project if Hospitality Inns uses ROI for performance evaluation? Why?
2. Why might Hospitality Inns want to use EVA instead of RI for evaluating the performance of the three hotels?
Problem 2) Investment Center Performance Evaluation Hospitality Inns owns and operates three hotels in three cities, San Francisco, Chicago, and New Orleans. The San Francisco Hotel was opened in 1988, Chicago Hotel was opened in 2001, and the New Orleans Hotel was opened in 2010. Hospitality has previously evaluated divisions based on Residual Income (RI), but the company is now considering changing to an EVA approach. All spas are assumed to face similar risks. The data for 2014 are as follow: St. Francisco Chicago New Orleans Total Revenue Variable Costs Fixed Costs Operating Income Interest on long-term debt (8%) Income before tax Net Income after tax (35%) $ 4,100,000$ 4,380,000 3,230,000$ 11,710,000 4,185,000 3,820,000 3,705,000 1,224,000 2,481,000 $ 553,800$ 503,100$ 555,750$ 1,612,650 1,600,000 1,280,000 1,220,000 368,000 852,000 1,630,000 1,560,000 1,190,000 16,000 774,000 955,000 980,000 1,295,000 440,000 855,000 $ 1,280,000$ 850,000 5,462,000 600,000$ 2,730,000 17,172,000 Current assets Long-term assets (Net of 4,875,000 6,835,000 depreciation Total Assets $ 6,155,000$ 6,312,000$ 7,435,000 $ 19,902,000 Note: Accumulated depreciation 2,200,0001,510,000 $ 220,000 Current liabilities Long-term debt Stockholders' equity 330,000 $ 265,000$84,000 $679,000 15,300,000 3,923,000 $ 6,155,000$ 6,312,000$ 7,435,000 $ 19,902,000 4,600,000 1,225,000 5,200,000 847,000 5,500,000 1,851,000 Total liability and stockholders equity $ 4,600,000$ 5,200,000$ 5,500,000 $ 15,300,000 $ 2,400,000$ 2,660,000$ 2,590,000 $ 7,650,000 Market value of debt Market value of equity Cost of equity capital Required rate of return 14% 11%Explanation / Answer
Part 1:
ROI calculation:
St. Francisco
Chicago
New Orleans
Net income after tax
553800
503100
555750
Total assets
6155000
6312000
7435000
Return on investment (ROI)
(553800 x 100/6155000)
8.997563
(503100 x 100/6312000)
7.970532
(555750 x 100/7435000)
7.474781
ROI after adding Saunas in the hotels:
ROI after installing saunas
St. Francisco
Chicago
New Orleans
Net income after tax
553800
503100
555750
Add: Operating income from saunas net of tax
{25000 - (25000 x 35%)}
16250
16250
16250
Net income after adding saunas
570050
519350
572000
Total assets
6155000
6312000
7435000
Add: Investment in Saunas
200000
200000
200000
New total assets after Saunas
6355000
6512000
7635000
ROI after installing saunas
St. Francisco
Chicago
New Orleans
(570050 x 100/6355000)
8.970102
(519350 x 100/6512000)
7.975276
(572000 x 100/7635000)
7.491814
ROI before Saunas:
St. Francisco
Chicago
New Orleans
Net income after tax
553800
503100
555750
Total assets
6155000
6312000
7435000
Return on investment (ROI)
(553800 x 100/6155000)
8.997563
(503100 x 100/6312000)
7.970532
(555750 x 100/7435000)
7.474781
Thus, as cane seen that the ROI of St. Francisco has reduced subsequent to the addition of Saunas with increase in ROI in other two hotels in Chicago and New Orleans.
No. the St. Francisco Hotel Manager would not accept the project if the Hospitality Inns uses ROI for performance evaluation as the Return on Investment (ROI) in case of the hotel is expected to reduce from 8.997% to 8.97% subsequent to the installation of Saunas.
Part 2:
Use of Residual income (RI) would not be helpful to the organization, i.e. Hospitality Inn as it takes into consideration the net income of the organization. Thus, Hospitality Inn should use EVA approach and not RI approach to evaluate the performance of the three hospitals. This will help to assess the efficiency of performance of the individual hotels better.
St. Francisco
Chicago
New Orleans
Net income after tax
553800
503100
555750
Total assets
6155000
6312000
7435000
Return on investment (ROI)
(553800 x 100/6155000)
8.997563
(503100 x 100/6312000)
7.970532
(555750 x 100/7435000)
7.474781
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