The adjacent table contains the details of four bonds currently traded in the market. Using this information calculate the no arbitrage price of a 3 year 8% annual coupon bond.

To Savor or to Groupon?

Mr. Chang, the owner of Enter the Dragon, a high-end Asian restaurant in Chicago, was puzzled by the choices put before him by the Groupon sales representative. He could offer a daily deal at Groupon (a $60 coupon for $30) that would be seen by hundreds of thousands of Groupon subscribers in the Chicago region, or he could offer a more tailored discount at Savored, a restaurant reservation site also owned by Groupon. Business had been slow lately, especially during weeknights, and Mr. Chang wanted to spur demand. He wanted to make sure, however, that he did so in a way that actually increased profits. He estimated that demand on weeknights was normally distributed, with a mean of 60 and a standard deviation of 30. Given a capacity of 100 and only a single seating per table per night, there were empty tables on many nights.

Groupon and the Daily Deal

Launched in 2008, Groupon expanded rapidly on the basis of its daily deals. The daily deal amounted to a 50 to 70 percent discount coupon for a product or service offered by a local business. The deal was broadcast by Groupon to its subscribers; if the number of buyers exceeded a threshold, the deal was finalized and the company shared about half the revenues with the local business while keeping the rest as its commission. The local business thus received about 20 to 25 cents on the dollar of retail value. Customers who purchased a coupon using the daily deal then contacted the local business for their product or service. At restaurants like Enter the Dragon, Groupon buyers tended to get their reservations as soon as they purchased their coupon, which was well before regular customers tried to get their reservations. The popularity of the daily deal among subscribers led to rapid growth at Groupon. After rejecting a $6 billion offer from Google, the company went public in 2011. Its stock has had a turbulent journey since then. After opening at $25, the stock hit a low of $4 by the end of 2012 before recovering to $10 by early 2014. The drop in price could be attributed in part to the higher marketing costs and the negative publicity from some retailers who had used the daily deal. Some complained that “the financials just can’t work,”2 whereas others called Groupon the “worst marketing ever.” Retailers complained that while Groupon brought in new customers, the margins were terrible because the 20 to 25 cents on the dollar recovered from a Groupon deal was much lower than the revenue the new customers provided. A very popular blog post by Jay Goltz on the New York Times3 site offered retailers a way to evaluate the benefit of the daily deal. He suggested that retailers think of Groupon as advertising. Instead of writing a check to the advertising agency, retailers using the daily deal were choosing to lose money on sales. Thus, the only calculation that mattered was the cost per new customer acquired from a daily deal. The blog post suggested the following eight key metrics to decide whether the daily deal was cost effective advertising:

1. Incremental cost of sales

2. Size of the average sale

3. Percentage of coupons redeemed

4. Percentage of coupons purchased by current customers

5. Number of coupons purchased per customer

6. Percentage of new coupon customers who become regular customers

7. Value of all Groupon subscribers seeing the daily deal

8. Current cost to acquire new customer through advertising

The value of the daily deal depended on these numbers. In an example described on the blog, Mr. Goltz focused on a restaurant that sold 3,000 coupons with a face value of $75 for $35 (the restaurant received only $17.50, with Groupon keeping the rest as commission). He assumed that the restaurant spent 40 percent (of normal revenue, not discounted revenue) in incremental cost; customers spent, on average, $85 ($10 more than the coupon); only 85 percent of the coupons were redeemed; 40 percent of the coupons were purchased by current customers; two coupons were purchased per customer; and about 10 percent of the new customers came back to the restaurant. In this case, the restaurant received a check of $52,500 (= 3000 * 17.50) from Groupon and additional revenues of $25,500 (= 3000 * 0.85 * 10) because the customers who came to the restaurant spent $10 more than the face value of the coupon. The incremental cost of serving these customers was $86,700 (= 3000 * 0.85 * 85 * 0.40). The restaurant thus lost $8,700 on this deal. If viewed as advertising expense, it was necessary to evaluate the number of new repeat customers that the deal brought in. Given that 2,550 (= 3000 * 0.85) coupons were redeemed and each customer bought two coupons, the deal was used by a total of 1,275 customers. Given that 60 percent of these were new customers, the deal brought 765 (= 1275 * 0.6) new customers to the restaurant. If 10 percent of them would return, the deal effectively brought in 76 new repeat customers. The restaurant then had to decide whether spending $8,700 to bring in 76 new repeat customers was more effective than other forms of advertising.

Savored and Restaurant Discounts

Groupon acquired Savored, a restaurant reservation engine, in September 2012. Savored offered discounts of up to 40 percent at upscale restaurants as long as customers made the reservations online in advance. Restaurants could vary the discount offered by time of day and day of week, with larger discounts for less popular times. Restaurants could

also vary the number of tables available at the discount price. Savored suggested times when discounts should be offered after studying a restaurant’s traffic patterns. For example, all Saturday night slots at the Capital Grille on Wall Street were discounted because it attracted a workweek crowd, whereas the Fatty Crab in the West Village in Manhattan offered only a Saturday night discount at 11 p.m.4 Savored had helped restaurants manage their idle capacity effectively. Le Cirque, an upscale Manhattan restaurant, had eliminated its cheaper pre-theater menu because Savored reservations filled those slots.

Study Questions

Use the spreadsheet Chapter16-Groupon for any supporting analysis.

1. Assume a variable cost of $10 per table and an average spending of $60 per table. With the daily deal ($60 for $30 coupon), Groupon provides Mr. Chang with a revenue of $15 per table. The analysis provided in the New York Times blog indicates that Mr. Chang makes money ($5 per table) through the daily deal (rather than incurring advertising expense). Do you think the analysis has included all aspects that need to be considered? Should Mr. Chang go ahead with the daily deal given that he can advertise while making a little bit of money per coupon?

2. With Savored, Mr. Chang can limit the number of tables he allows for the discount price. Assuming he makes the same revenue with Savored per discounted table as the daily deal ($15), do you think the ability to limit the number of tables at discount has any advantages? Would you prefer to use Savored or the daily deal?

3. Would you prefer to use Savored or the daily deal? Why?

You are the CFO of MacroWare Company. Your company’s stock is traded in the NYSE. Your company wants to invest in a telecommunication technology. You were told by the operation and marketing departments that the project is very promising. You are considering the finance department’s suggestion to issue stocks to finance the project.

As a leader of the company, your objective is supposed to _____.  

a. maximize the company’s earnings

b. maximize the company’s earnings per share c. maximize the company’s stock value per share d. maximize social well-being  

You are supposed to act for the best interest of _____.

a. managers  

b. board of directors  

c. existing shareholders

d. potential or future shareholders

The NYSE is a/an _____, in which _____ make a market.

a. OTC market, brokers

b. OTC market, specialists

c. organized exchange, brokers

d. organized exchange, specialists

If you agree with the finance department’s suggestion to issue stocks to raise funds, the stocks will be issued in the _____.  

a. organized exchange

b. secondary market

c. OTC market   

d. IPO market

The current stock price is directly affected by _____.  

a. investors’ anticipation of the company’s future performance (or profitability)

b. the company’s past performance

c. neither a nor b

If the news about the project is announced to the public, the stock price would ____.  

a. increase   

b. decrease

c. unchanged

If you agree with the finance department’s suggestion to issue additional shares to raise funds, shares should be issued _____.  

a. before the announcement of the news about the project   

b. after the announcement of the news about the project

c. either before or after the announcement, the timing doesn’t matter.

If your company also has enough retained earnings to finance the project and at the same time it is able to issue corporate bonds to raise funds, you would like to use _____ to finance the project investment.  

a. retained earnings  

b. bond issues

c. stock issues   

d. there is no difference among the above three.

In the following years, you project generates substantial profits and you want to reward shareholders by paying out some retained earnings. You can reward them by the following three means: cash dividends, stock dividends, stock repurchases. How do cash dividends, stock dividends and stock repurchases affect the stock price respectively?  

a. increase, increase, decrease

b. decrease, increase, increase   

c. decrease, decrease, increase

d. decrease, decrease, decrease  

You are considering how to reward shareholders, cash dividends, stock dividends, or stock repurchases. We know that in terms of tax for the company, these three ways are the same—none of them affect the company-level tax. In terms of tax for shareholders, which of the followings is the worst choice?  

a. cash dividends

b. stock dividends

c. stock repurchases

d. there is no difference between them

Eliseth Ltd is a public company whose shares are traded on the ASX. A former executive was formally accused of fraud last month. This executive used his influence with three major suppliers to increase the price of the inventories’ contracts for the last three years. Eliseth identified those contracts and estimated a loss around AUD 5 billion which this amount was paid by Eliseth in the past three years. The inventory was recorded at cost. Using the appropriate accounting standard and the new conceptual framework issued by IASB in 2018 respond:

What would you recommend Eliseth to do? You must provide the basis of your recommendation.

M.K. Gallant is president of Kranbrack Corporation, a company whose stock is traded on a national exchange. In a meeting with investment analysts at the beginning of the year, Gallant had predicted that the company’s earnings would grow by 20% this year. Unfortunately, sales have been less than expected for the year, and Gallant concluded with two weeks of the end of the fiscal year that it would impossible to ultimately report an increase in earning as large as predicted unless some drastic action was taken. Accordingly, Gallant has ordered that wherever possible, expenditures should be postponed to the new year – including canceling or postponing orders with suppliers, delaying planned maintenance and training, and cutting back on end-of-the-year advertising and travel. Additionally, Gallant ordered the company’s controller to carefully scrutinize all costs that are currently classified as period costs and reclassify as many as possible as product costs. The company is expected to have substantial inventories of work in process and finished goods at the end of the year.

1. Identify at least two viable alternative courses of action that you might take to address this ethical issue.

2. Make and justify recommendations for successful resolution of the ethical dilemma.  

UltraMX Corp., an all equity exchange traded company, is planning to invest in a project as follows:

• Initial investment = $100 million.
• The project is financed with debt and equity in same proportion (i.e., one part of debt to one part of equity).
• Expected cash flows after tax = $10 million in perpetuity.
• Tax rate = 25%
• Cost of debt after tax of project (4%)
• Equity beta of project = 1.5
• UltraMX beta = 0.8
• Market risk premium (MRP) =6%.
• Risk-free rate = 3%.

Based on above information, answer the following questions:

1. Calculate the appropriate discount rate (cost of capital) for UltraMX project.

2. Determine whether UltraMX should accept or reject the project using NPV and IRR, respectively.

3. Assume the current market value of the firm is $500 million and markets are efficient in the semi-strong form:

1) what would happen to the value of the firm after announcing the project?

2) what would be the percent change in the share price of UltraMX after announcing the project?

3) what would be the fair value of UltraMX after announcing the project?

Lant Company has provided the following information:

• Cash sales totaled $220,000.
• Credit sales totaled $482,000.
• Cash collections from customers for services yet to be provided totaled $82,000.
• A $18,000 loss from the sale of property and equipment occurred.
• Interest income was $8,000.
• Interest expense was $18,200.
• Supplies expense was $320,000.
• Rent expense for the store was $32,000.
• Wages expense was $42,000.
• Other operating expenses totaled $72,000.
• Unearned revenue was $4,900.

What is the amount of Lant’s income before income taxes?

Multiple Choice

A)$207,800

B)$218,000

C)$382,000

D)$289,800

Horizon Inc. sells prepaid telephone cards to customers. Horizon then pays the telecommunications company, V-Mobile, for the actual use of its telephone lines related to the prepaid telephone cards. Assume that Horizon sells $6,000 of prepaid cards in January 2020. It then pays V-Mobile based on usage, which turns out to be 60% in February and 40% in March. The total payment by Horizon for V-Mobile lines over the 2 months is $4,000.

A. Prepare the journal entries necessary for January and February

B. Compute the revenue, costs and net income Horizon will report in January, February, and March

Simulation Case Study:
Phoenix Boutique Hotel Group

Phoenix Boutique Hotel Group (PBHG) was founded in 2007 by Bree Bristowe. Having worked for several luxury resorts, Bristowe decided to pursue her dream of owning and operating a boutique hotel. Her hotel, which she called PHX, was located in an area that included several high-end resorts and business hotels. PHX filled a niche market for “modern travelers looking for excellent service and contemporary design without the frills.” Since opening PHX, Bristowe has invested, purchased, or renovated three other small hotels in the Phoenix metropolitan area: Canyon Inn PHX, PHX B&B, and The PHX Bungalows.

One of the customer service enhancements Bristowe has implemented is a centralized, toll-free reservation system. Although many customers book specific hotels online, the phone reservation system enables PBHG to find the best reservation match at all properties. It has been an excellent option for those customers who have preferences regarding the type of room, amenity options, and the best price across the four hotel locations.

Currently, three agents are on staff for the 6 a.m. to 2 p.m. call shift. The time between calls during this shift is represented in Table 1. The time to process reservation requests during this shift is in Table 2.

Table 1: Incoming Call Distribution

Table 2: Service Time Distribution

Bristowe wants to ensure customers are not on hold for longer than 2 minutes. She is debating hiring additional staff for this shift based on the available data. Additionally, Bristowe and PBHG will soon be featured in a national travel magazine with a circulation of over a million subscriptions. Bristowe is worried that the current operators may not be able to handle the increase in reservations. The projected increase for call distribution is represented in Table 3.

Table 3: Incoming Call Distribution

Bristowe has asked for your advice in evaluating the current phone reservation system. Create a simulation model to investigate her concerns. Make recommendations about the reservation agents.