Problem 2: Siebach Farm-All Group (35 points)

Siebach Farm-All Group operates organic produce farms in Vernal, Utah and Yakima, Washington. Siebach Farm-All currently evaluates division managers based on return on investment (ROI), but the company is considering changing their performance evaluation system to an EVA approach. Data for 2022 are as follows:

	Vernal Farm	Yakima Farm	Total
Revenues	$3,900,000	$3,130,000	$7,030,000
Leasing and other costs	2,300,000	1,655,000	3,955,000
Advertising costs	575,000	830,000	1,405,000
Operating income	1,025,000	645,000	1,670,000
Interest and taxes	462,600	437,000	899,600
Net income	562,400	208,000	770,400
Net book value at 2022 year-end:
Current assets	$1,280,000	$600,000	$1,880,000
Long-term assets	5,375,000	6,535,000	11,910,000
Total assets	6,655,000	7,135,000	13,790,000
Current liabilities	$330,000	$84,000	$414,000
Long-term debt	4,600,000	5,500,000	10,100,000
Stockholders' equity	1,725,000	1,551,000	3,276,000
Total liabilities and equity	6,655,000	7,135,000	13,790,000
WACC			9.5%
Accumulated depreciation	$2,220,000	$220,000

Siebach Farm-All pays a 22% tax rate on net operating profits after deducting interest expense.

Siebach Farm-All believes that advertising provides benefits over 2 years and therefore for EVA purposes should be amortized on a straight-line basis over a 2-year useful life (beginning with the year of the expenditure). Advertising for 2022 is shown in the table above. Advertising for 2021 for the Vernal and Yakima farms was $550,000, and $450,000, respectively.

Required:

1. For each of the farms, calculate 2022 ROI using operating income as the numerator measure of income and total assets as the denominator measure of investment. Do not make any non-GAAP adjustments for this calculation. (5 points)

2. Suppose that Siebach Farm-All is considering adding new tractors from Kubota. For each farm, the new tractors would cost $425,000 and would be expected to result in an incremental increase in operating income of $60,000.

a. What is the incremental ROI and what effect would the addition of the tractors at the Vernal farm have had on 2022 ROI for Vernal? If performance evaluation is based on ROI, would the Vernal farm manager have an incentive to accept or reject this project? Explain your answer. (3 points)

b. What is the incremental ROI and what effect would the addition of the tractors at the Yakima farm have had on 2022 ROI for Yakima? If performance evaluation is based on ROI, would the Yakima farm manager have an incentive to accept or reject this project? Explain your answer. (2 points)

3. Assume Siebach Farm-All did not add the tractors from part 2. Calculate 2022 EVA for each of the farms. (15 points)

4. Refer back to the information and assumptions about adding the tractors in part 2. For each farm, explain whether the manager has an incentive to add the new tractors if they are evaluated based on EVA instead of ROI. Assume that the managers receive incentive compensation equal to 10% of EVA. (5 points)

5. The management team at Siebach Farm-All has asked for your recommendation about whether they should continue to use ROI for performance evaluation or if they should shift their focus to EVA. Provide one advantage and one disadvantage to making the switch, and an overall recommendation (no more than 3-4 sentences). (5 points)