P.F. Skidaddle\'s operates casual dining restaurants in three regions: Denver, S

Question

P.F. Skidaddle's operates casual dining restaurants in three regions: Denver, Seattle and Sacramento. Each geographic market is considered a separate division. The Denver division is made up of four resturants, each built in early 2002. The Seattle division is made up of three resturants, each built in January 2006. The Sacramento division is the newest, consisting of three restaurants built four years ago. Division managers at P.F. Skidaddle's are evaluated on the basis of ROI. The following information refers to the three divisions at the end of 2012 : Denver Seattle Sacramento Total Division Rev $8365000 $6025000 $5445000 $20138000 Division Exp 7945000 5521000 4979000 18445000 Division Op Inc 723000 504000 466000 1693000 Gross BV of long-term assets 4750000 3750000 4050000 12300000 Acc Dep 3300000 1750000 1080000 6130000 Current Assets 999800 768200 824600 2592600 Dep Exp 300000 250000 270000 820000 Construction cost index for year of construction 100 110 118 1. Calculate ROI for each division using net BV of total assets. 2. Using the technique in Exhibit 23-2, compute ROI using current-cost estimates for long-term assets and depreciation expense. Construction cost index for 2012 is 122. Estimated useful life of operational assets is 15 years. 3. How does the choice of long-term asset valuation affect management deecisions regarding new capital investments? Why might this be more significant to the Denver division manager than to the Sacramento division manager?

Explanation / Answer

1) ROI=Operating Income /Net BV of Assets

Net Book Value of Total Assets: Gross Book Value of Long Term Assets - Accumulated Depreciation- Depreciation for the Current Year+ Value of Current Assets

Denver=4,750,000- 3,300,000- 300,000+999,800= 2,149,800

Seattle=3,750,000 -1,750,000-250,000+768,200=2,518,200

Sacramento=4,050,000 -1,080,000-270,000+824,600=3,524,600

Therefore ROI

Denver: 723,000/2,149,800=33.63%

Seattle: 504,000/2,518,200=20.01

Sacramento: 466,000/3,524,600=13.22%

2)

Step 1:

Restating Gross Book Value of Assets at Historical Cost to Gross Book Value of Assets at Current Cost:

Gross BV of Long Term Assets × (Construction Cost Index at 2012/Construction Cost Index in Year of Construction)

Denver : 4,750,000×(122/100)=5,795,000

Seattle:   3,750,000×(122/110)=4,159,091

Sacramento: 4,050,000×(122/118)=4,187,288

Step 2:

Net BV of Long Term Assets at Current Cost: Gross BV of Assets at Current Cost×(Estimated Remaining Useful Life/Estimated Total Useful Life)

(Note Useful Life of all machine is given as 15 years)

Denver: 5,795,000 × (4/15) = 1,545,333

Seattle= 4,159,000 × (8/15 )= 2,218,182

Sacramento= 4,187,288 × (12/15)= 3,349,830

Step 3:

Current Cost of Total Assets at end of 2012 (Assumption all current assets are given in 2012 dollars)

Denver= 1,545,333+999,800=2,545,133

Seattle= 2,218,182+768,200=2,986,382

Sacramento= 3,349,830+824,600=4,174,430

Step 4

Current Cost Depreciation Expense

Denver= 5,795,000/15=386,333

Seattle= 4,159,091/15=277,273

Sacramento= 2,700,000/15=279,153

Step 5

2012 Operating Income using current cost depreciation expense:

Operating Income-(Current Cost Depreciation Expense-Historical Cost Depreciation Expense)

Denver=723,000.00-(386,333-300,000.00)=636,667

Seattle=504,000-(277,273-250,000)=476,728

Sacramento=466,000-(279,153-270,000)=456,847

Step 6  

              Therefore, ROI (Step 5/Step 3)

            Denver=636,667/2,545,133= 25%

             Seattle=476,728/2,986,382=16%

             Sacramento=456,847/4,174,430= 11%

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