Coral Hotel PLC operates branches in Dhahran, Khobar, and Riyadh. The Dhahran Branch was the company’s first, opened in 1999. The Khobar Branch opened in 2005, and Riyadh Branch opened in 2007. Coral Hotel has previously evaluated branches based on return on investment (ROI) and then residual income (RI). Carol Mays, the Coral Hotel Group manager is concerned that the focus on annual ROI could have an adverse long-run effect on the branches and the group's performance, in particular, it might cause managers to ignore emerging threats and opportunities. However, the company is considering changing to an economic value added (EVA) approach. All branches are assumed to face similar risks. Data for 2019 follow:

Dhahran Khobar Riyadh Total

Revenues $4,100,000 $4,380,000 $3,230,000 $11,710,000

Variable costs 1,600,000 1,630,000 955,000 4,185,000

Fixed costs 1,280,000 1,560,000 980,000 3,820,000

Operating income 1,220,000 1,190,000 1,295,000 3,705,000

Interest costs on long-term debt at 8% 368,000 416,000 440,000 1,224,000

Income before taxes at 35% 852,000 774,000 855,000 2,481,000

Net income 553,800 503,100 555,750 1,612,650

Net book value at 2019 year-end:

Current assets 1,280,000 850,000 600,000 2,730,000

Long-term assets 4,875,000 5,462,000 6,835,000 17,172,000

Total assets 6,155,000 6,312,000 7,435,000 19,902,000

Current liabilities 330,000 265,000 84,000 679,000

Long-term debt 4,600,000 5,200,000 5,500,000 15,300,000

Stockholders’ equity 1,225,000 847,000 1,815,000 3,923,000

Total liabilities and stockholders’ equity 6,155,000 6,312,000 7,435,000 19,902,000

Market value of debt 4,750,000 5,350,000 5,800,000 15,900,000

Market value of equity 2,500,000 2,750,000 2,650,000 7,900,000

Cost of equity capital 13%

Required rate of return 12%

Accumulated depreciation on long-term assets 2,200,000 1,510,000 220,000

Required:

1. Use the DuPont method of profitability analysis to evaluate the performance of the three hotel branches for the year 2019. Use 2019 total assets as the investment base. Show your calculations and comment on the results.

2. Comment on the potential strengths and weaknesses of using the DuPont method of profitability for measuring branch performance at Coral Group. What factors affecting ROI does the DuPont method of profitability analysis highlights?

3. Calculate residual income (RI) for each of the hotel branches using operating income as a measure of income and total assets minus current liabilities as the measure of investment.

4. Ahmed Omran, the Riyadh branch manager, argues that Khobar and Dhahran branches have “loaded up on lot of short-term debt” to boost their RI. Calculate an alternative RI for Dhahran branch only that is not sensitive to the amount of short-term debt taken on by the branch. Comment on the results.

5. Refer back to the original data. Calculate the WACC for Coral Hotel’s branches.

6. Refer back to the original data. Calculate the EVA for each of the hotel branches, using net book value of long-term assets. Use your preceding calculations to comment on the relative performance of each branch.

Answer rating: 100% (QA)

Particulars Interest Net income NOPAT Net income Interest Cost costs on longterm debt at 8 Calculati... View the full answer