Question

You are an Analyst for the professional service firm, FINACC LLP. Your firm specializes in providing a wide variety of internal business solutions for different clients. It is your first day on the job and a Manager in the Consulting area asks you for some help with an investment decision for one of your large clients, Big Spenders Inc. Ready to make an impression on your first day, you start reading the background information provided by the Manager.

Additional Information

Big Spenders Inc. has been working on diversifying its portfolio of investments and requires accounting advice for a decision between two car cleaning and detailing companies. Your responsibility is to perform a comparative analysis of the profitability of two potential equity investments. Your engagement manager on this job has given you a brief background on the operations of the two companies:

Auto Wash Bot Ltd. (AWBL) has recently completed the research and development of a new touch screen app for all mobile devices. This new technology is both more user friendly than the current technology on the market. Auto Wash Bot Ltd has just signed a major contract to provide the Auto Wash Bot terminal to a major producer of mobile devices. The founder of the business would like to sell a 50% interest in the business for $100,000 in order to finance further expansion of operations.

Popeye’s Muscle Wash Ltd (PMWL) is a self-service, coin operated car wash located in a busy residential area. The company provides all of the services of a typical car wash, including soap, wax, vacuuming as well as pressure washing. PMWL has been long established and enjoys the loyalty and repeat business of many local residents. The current owner is getting up in age and would like to sell 100% ownership interest in the business for $100,000 to pursue retirement. The current year’s income statement is consistent with prior years.

One of the first tasks in the analysis of the potential equity acquisition is an assessment of each company’s current and future profitability. Your manager has provided you with copies of each company’s income statement (see below). Next, you are to calculate the expected return on the investment for each company. You have been asked to discuss any other issues that you believe are relevant to the investment decision.

The Consulting Manager would like you to prepare the report and have it on his desk for review first thing tomorrow morning. Once reviewed, this report will be submitted to Big Spenders Inc. in order to support their decision.

Auto Wash Bot Ltd.

Income Statement

For the Year Ended December 31, 2015

Revenue	$375,000
Cost of Goods Sold	86,250
Gross Profit	288,750
Other Expenses
Advertising	35,400
Office Expense	22,750
Research	195,000
Wages and Salaries	40,000
Total Other Expenses	293,150
Income Before Taxes	(4,400)
Income Tax	0
Net Income	$(4,400)

Popeye’s Muscle Wash Ltd

Income Statement

For the Year Ended December 31, 2015

Revenue	$375,000
Cost of Goods Sold	163,125
Gross Profit	211,875
Other Expenses
Advertising	5,200
Office Expense	17,400
Repairs and Maintenance	85,000
Wages and Salaries	50,000
Total Other Expenses	157,600
Income Before Taxes	54,275
Income Tax*	8,413
Net Income	$45,862

  

*Tax rate of 15.5% used.

Note to students: Issues are hidden within the case. It is your responsibility to read the case facts and identify the critical issues required for discussion and analysis.

Answer 1

SOLUTION- First lets compare both investment options side by side -

Investment		$100,000		Investment	$100,000
Ownership Stake		50%		Ownership Stake	100%
AWBL		PMWL
Revenue		$375,000		Revenue	$375,000
Cost of Goods Sold		86,250		Cost of Goods Sold	1,63,125
Gross Profit		2,88,750		Gross Profit	2,11,875
Other Expenses				Other Expenses
Wages and Salaries		40000		Wages and Salaries	50,000
Research		195000		Office Expense	17,400
Office Expense		22750		Repairs and Maintenance	85,000
Advertising		35400		Advertising	5200
Total Other Expenses		2,93,150		Total Other Expenses	1,57,600
Income Before Taxes		-4,400		Income Before Taxes	54,275
Income Tax		0		Income Tax*	8,413
Net Income		$(4,400)		Net Income	$45,862
Current Profitability		$(4,400)		Current Profitability	$45,862
Future Profitability		$161,057		Future Profitability	$45,862
(-4400+195000-29543)
Expected ROI		(50% of $161,057)/100,000		Expected ROI	(100% of $45,862)/100,000
		80.52%			45.86%

Note 1 : For Auto Wash Boot LTD. because research is done and it is not being held for every year so from next financial year it will not incur which will make a profit of $190600 and after reducing tax at 15.5% which is $29543, net profit will be $161,057 from next year onwards.

Note 2- No sales growth is considered here. Sales is accounted same year by year for the purpose of research.

Note 3- For PMWL its all operating sort of activities is repeating in nature so no further growth can be expected right now.

Other Considerations:              
1 Since AWBL has endorsed a significant contract with mobile company, its sales would go up, and its production cost is also very low compared to PMWL, resulting in higher profit.
2 Because PMWL is limited to Residential area and also not promoting very much, its business income is constant in nature.
              
Conclusion: Considering above facts it is evident that AWBL has a higher return on income and a growth-oriented firm, so investment in AWBL will be advantageous.

(PLEASE UPVOTE IF YOU LIKE THE ANSWER)