Question

Central Adventures

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, and needs some advice from her accountant on how to proceed.

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

Central 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 rollercoaster 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, 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.

Central 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 pay rate, which he says he will accept if his performance is not appropriately acknowledged.

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. Central Adventures has a $86,000 mortgage payment on the land and buildings for Treetops, which would still need to be paid 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
# of tickets sold	1,564,755	419,750	30,240
# of employees	540	200	32
Average net operating assets	$21,065,000	$13,452,000	$420,000
Gross margin	$18,135,510	$3,601,455	$1,022,112
Selling and administrative costs	$13,259,520	$944,620	$231,900

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 required rate of return of 12 percent (set at the company’s weighted-average cost of capital) and are subject to 18% income taxes.

Fatima needs to see 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 multilevel income statement for Central Adventures.

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

c. Did Janet Lieberman (the Funland park manager) make the ‘right’ decision (i.e., was it in Central Adventure’s overall best interest for Funland to reject the new rollercoaster)? Explain your answer. Provide the appropriate financial analysis(es) to support your conclusion.

d.   Is David Copperfield’s (the Waterworld park manager) complaint valid? Or would a different performance metric tell the same story?

e. Provide a recommendation on whether to close Treetops. Provide the appropriate financial analysis to support your conclusion.

f.    Provide a recommendation on a different allocation base for corporate overhead.

Answer 1

e.It is recommended to close Treetops since this park has lost popularity in recent years, and has been ‘in the red’ for the past two years.This will result in inflow of 2,50,000/- and the 86,000/- of land & buildings mortgage can be paid off.

c.Janet Lieberman is correct is not to acquire the new roller coaster.

Its total cost=80,00,000 +(20*1,25,000)=105,00,000 is more than the projected benefits of 11,90,000.

d.David Copperfield's complaint is valid.The ROI of Waterworld is considerably higher than Funland.

f.The corporate overheads should be allocated on the basis of number of employees in each park.

b. Funland Waterworld Treetops

A.Sales 59,460,690 10,913,500 19,65,600

B.Selling

& admin cost 13,259,520 9,44,620 2,31,900

C.Corporate cost

allocated equally 8,47,640 8,47,640 8,47,640

D.Total cost 14,107,160 17,92,260 10,79,500

E.Net profit (A-D) 45,353,530 91,21,240 8.86,100

F.ROI (E/D) 3.21 5.09 0.82

G.Avg net

operating asset 21,065,000 13,452,000 4,20,000

H.Wt.Cost of Capt 12% 12% 12%

I.G*H 25,27,800 16,14,240 50,400

J.Residual income=Operating income-(Operating assets*cost of capital)

(E-I) 42,825,730 75,07,000 8,35,700

EVA=Net Operating profit after tax-(Weighted average cost of capital*capital invested)

K.Net Operating

profit after tax (E*0.82) 37,189,894.60 74,79,416.80 7,26,602

L.EVA Funland 37,189,894.60-(0.12*14,107,160)

=35,497,035.40

Waterworld 74,79,416.80-(0.12*17,92,260)

=72,64,345.60

Treetops 7,26,602-(0.12* 10,79,500)

=5,97,062

a. Funland Waterworld Treetops

A.Sales 59,460,690 10,913,500 19,65,600

B.Selling

& admin cost 13,259,520 9,44,620 2,31,900

C.Corporate cost

allocated equally 8,47,640 8,47,640 8,47,640

D.Total cost 14,107,160 17,92,260 10,79,500

E.Net profit (A-D) 45,353,530 91,21,240 8.86,100