Question

Fatima Hopkins, the CEO of Central Adventures, is having difficulties with all three of her top management level employees. With one manager making questionable decisions, another threatening to leave, and the third likely ‘in the red’, Fatima is hoping there is a simple answer to all her difficulties. She is asking you (her accountant) for some advice on how to proceed.

Central Adventures owns and operates three amusement parks in Michigan: Funland, Waterworld, and Treetops. Central Adventures has a decentralized organizational structure, where each park is run as an investment center. Park managers meet with the CEO at least once annually to review their performance, where each park manager’s performance is measured by their park’s return on investment (ROI). The park manager then receives a bonus equal to 10% of their base salary for every ROI percentage point above the cost of capital.

Fatima’s first difficulty is with the Funland park. Funland is an outdoor theme park, with twelve roller coaster rides and several other attractions. This park has first opened 1965, and most of the rides have been in operation for 20+ years. Attendance at this park has been relatively stable over the past ten years. The park manager of Funland, Janet Lieberman, recently shared with Fatima a proposal to replace one of their older rides with a new roller coaster, a hybrid steel and wood roller coaster with a 90 degree, 200 foot drop and three inversions. The proposal indicated that the ride would cost $8,000,000 with an estimated life of 20 years. In addition, this new style of coaster would require additional maintenance and insurance, costing $125,000 each year. However, it projected that this new attraction would boost attendance, earning the park an additional $1,190,000 per year in revenues. Janet ultimately decided not to invest in this new attraction. Fatima (doing a quick mental calculation) saw that the investment had a payback period of eight years—much shorter than the life of the roller coaster—and is perplexed at Janet’s decision.

The second dilemma concerns the Waterworld park. Waterworld is an indoor water park, operating year-round. Run by park manager David Copperfield, Waterworld was built in 2016 and has increased attendance by 20% every year since. David recently sent you an email complaining that, based on the current bonus payout schedule, Janet Lieberman’s bonus last year was significantly higher than his. He points to the increasing attendance, and says that his park is being punished for having opened so recently (his park assets are much more recent than the roller coasters at Funland). He currently has an employment offer from another company at the same base pay rate, which he says he will accept if his performance is not appropriately acknowledged. Fatima needs to look at the relative performance across parks to determine how to proceed with David.

Central Treetops includes a high ropes course and has a series of ziplines that criss-cross over the Chippewa River. For many years, it was a popular venue for corporate team-building activities, so it is equipped with a main indoor facility with cafeteria and overnight guest rooms. This park has lost popularity in recent years, and has been ‘in the red’ for the past two years. If the park is not profitable this year, you will need to decide whether to close it - permanently. Included in the ‘Fixed COGS’ for Treetops is a $86,000 mortgage payment on the land and buildings for the park, which would still need to be paid by Central Adventures if the park is closed. Incidentally, you recently had a conversation with the regional head of the YMCA, who would like to open a summer camp in the central Michigan region. If you decided to close Treetops, you are fairly certain that you could lease that land to the YMCA for $250,000 annually.

A partial report of this year’s financial results for Central Adventures shows the following:

	Funland	Waterworld	Treetops
Sales	$59,460,690	$10,913,500	$1,965,600
Fixed COGS	$10,351,870	$4,284,530	$170,430
Variable COGS	$39,757,310	$2,220,695	$746,928
Selling and administrative costs	$3,259,520	$944,620	$231,900
Average operating assets	$21,014,000	$13,452,000	$420,000
# of tickets sold	1,564,755	419,750	30,240
# of employees	540	200	32

The ‘Selling and administrative costs’ are all incurred directly by each park, and are determined at the beginning of each year (that is, they do not change with the number of tickets sold). In addition to the information above, there are $2,542,920 in corporate costs, which are currently allocated evenly between the three parks. These costs are primarily due to employee benefits costs, which are billed at the corporate level. If the Treetops park is closed, the allocated corporate costs would decrease by $12,000. Central Adventures has a cost of capital of 12 percent (and Fatima uses the cost of capital as their required rate of return) and are subject to 18% income taxes.

Fatima needs to evaluate this year’s performance results before she can make any decisions. Is David’s complaint about the performance evaluation metrics valid? Is that also affecting management decisions in the form of Janet’s rejection of the proposed new rollercoaster? And is the company better off without Treetops? She sets off to the company accountant’s office to help get some answers.

a.     Create a segmented income statement for Central Adventures.

b.     Calculate the current annual ROI, residual income and EVA for the three parks.

c.    why it was/was not in Central Adventure’s overall best interest for Funland to reject the new rollercoaster.

d.     is David Copperfield’s (the Waterworld park manager) complaint valid? Explain why it is (or is not valid), and what further information would be necessary.

e.     why should they close/ not close treetops.

f.      what should you recommend she do to improve the evaluation of park manager performance measurement at Central Adventures.

Answer 1

a	segmented income statement for Central Adventures.
					"$"
		Funland	Waterworld	Treetops	TOTAL
1	Sales	5,94,60,690	1,09,13,500	19,65,600	7,23,39,790
	operating expenses
	Variable COGS	3,97,57,310	22,20,695	7,46,928	4,27,24,933
	Selling and administrative costs	32,59,520	9,44,620	2,31,900	44,36,040
	Fixed cost
	Fixed COGS	1,03,51,870	42,84,530	1,70,430	1,48,06,830
	corporate expenses	8,47,640	8,47,640	8,47,640	25,42,920
2	TOTAL EXPENSES	5,42,16,340	82,97,485	19,96,898	6,45,10,723
3	GROSS INCOME
	(SALES - EXPENSES )	52,44,350	26,16,015	-31,298	78,29,067
	INCOME TAX @ 18%	9,43,983	4,70,883		14,09,232
4	NET INCOME	43,00,367	21,45,132	-31,298	64,19,835
b	Calculation of the current annual ROI, residual income and EVA for the three parks.
5	Average operating assets	2,10,14,000	1,34,52,000	4,20,000	3,48,86,000
6	Return on income ( 4/5)	20%	16%	-7%	18%
7	cost of capital ( given)	12%	12%	12%	12%
8	Residual income 3 - (7 * 5)	2722670	1001775	-81698	3642747
9	Economic value added 4 -(7*5)	1778687	530892	-81698	2233515
c	why it was/was not in Central Adventure’s overall best interest for Funland to reject the new rollercoaster?
Answer	It was such because investment had a payback period of eight years—much shorter than the life of the roller coaster
d	is David Copperfield’s (the Waterworld park manager) complaint valid? Explain why it is (or is not valid), and what further information would be necessary?
Answer	David s complaint is invalid because the ROI of the Waterworld is less by 4 % when compared to Funland.
e	why should they close/ not close treetops?
Answer	Treetops Is already incurring losses and if it would be closed down   -
	‘Fixed COGS’ for Treetops is an $86,000 mortgage payment on the land and buildings for the park, which would still need to be paid by Central Adventures if the park is closed.
	And the corporate cost of the other 2 parks is decreased by 12000 $
	And the same place can be rented out for summer camp @ 250000 and thereby Fixed COGS can also be recovered
f	what should you recommend she do to improve the evaluation of park manager performance measurement at Central Adventures.
Answer	Refer e