QUESTION 2. Robinson CinemaPlex has large movie theater complexes in New Orleans
ID: 2590881 • Letter: Q
Question
QUESTION 2.
Robinson CinemaPlex has large movie theater complexes in New Orleans, Memphis, and Nashville. Each location is run independently, with head office located in New Orleans. The three complexes are similar in that they each have 12 screens. The Nashville location is only a year old, the Memphis location is 3 years old, and the New Orleans location is 6 years old. The head office uses ROI to evaluate performance. The table below presents each CinemaPlex location for last year.
Revenues
Variable Costs
Fixed costs (incl depreciation)
Invested capital based on book value
Annual depreciation
New Orleans
$8,500,000
$2,800,000
$2,400,000
$18,000,000
$1,200,000
Memphis
8,300,000
2,600,000
2,200,000
21,000,000
1,300,000
Nashville
8,650,000
2,250,000
2,500,000
27,000,000
1,400,000
The head office uses 10% as the required rate of return. It also depreciates its assets using straight-line depreciation (and there have been no changes in depreciation over time).
2-1. Create a table with the three locations as rows. The next four columns will contain ROI and residual income—first set using net book value and the second set using gross book value.
2-2. Discuss the differences between the two measures and choice of how to value to investments on the ranking of the three locations. Which method would be argued for by the New Orleans theater and which by the Nashville theater? What should headquarters choose?
Revenues
Variable Costs
Fixed costs (incl depreciation)
Invested capital based on book value
Annual depreciation
New Orleans
$8,500,000
$2,800,000
$2,400,000
$18,000,000
$1,200,000
Memphis
8,300,000
2,600,000
2,200,000
21,000,000
1,300,000
Nashville
8,650,000
2,250,000
2,500,000
27,000,000
1,400,000
Explanation / Answer
2-1.
2-2.
The gross book value and the net book value method of calculating ROI and residual income brought different results. But one thing was common that net book value brought better ROI and more residual income for the three locations than based on gross book value. So, it is obvious from the three situations is that net value brings more result.
Now in the case of New Orleans theater calculating on the basis of gross book value will not be justiceful as it was established 6 years ago and many portion of the investment is depreciated already. So if caculations done and considered on the basis of gross book value that will be questionable.
Again Nashville has established a year ago. Here also if the total amount of gross book value is taken, which is meant for a invenstment of long term period, and the calculations are done then the report of Nashville will show a reduced ROI. In stead if net book value is considered for calculations, it will show an actual amount upto an extent.
So, the headquarter should choose the net book value for calculations of different aspects.
New Orleans Memphis Nashville A. Total revenues 8500000 8300000 8650000 B. Less: Expenses Variable costs 2800000 2600000 2250000 F.C. (exclusive depreciation) 1200000 900000 1100000 C. Income (A-B) 4500000 4800000 5300000 D. Invested capital book value 18000000 21000000 27000000 E. Total depreciation pending 6 years 3 years 1 year F. Annual depreciation 1200000 1300000 1400000 G. Accumulated depreciation (E*F) 8400000 3900000 1400000 H. Invested capital Net book value (D-G) 9600000 17100000 25600000 I. Required rate of return 10% 10% 10% J. Required profit on gross book value (D*I) 1800000 2100000 2700000 K. Residual income on gross book value (C-J) 2700000 2700000 2600000 L. Required profit on net book value (H*I) 960000 1710000 2560000 M. Residual income on net book value (C-L) 3540000 3090000 2740000 N. ROI based on gross book value [(C/D)*100] 25% 22.86% 19.63% O. ROI based on net book value [(C/H)*100] 46.88% 28.01% 20.70%