CentralAdventures
Fatima Hopkins, the CEO of Central Adventures, is havingdifficulties with all three of her top management level employees.With one manager making questionable decisions, another threateningto leave, and the third likely ‘in the red’, Fatima is hoping thereis a simple answer to all her difficulties. She is asking you (heraccountant) for some advice on how to proceed.
Central Adventures owns and operates three amusement parks inMichigan: Funland, Waterworld, and Treetops. Central Adventures hasa decentralized organizational structure, where each park is run asan investment center. Park managers meet with the CEO at least onceannually to review their performance, where each park manager’sperformance is measured by their park’s return on investment (ROI).The park manager then receives a bonus equal to 10% of their basesalary for every ROI percentage point above the cost ofcapital.
Fatima’s first difficulty is with the Funland park. Funland isan outdoor theme park, with twelve roller coaster rides and severalother attractions. This park has first opened 1965, and most of therides have been in operation for 20+ years. Attendance at this parkhas been relatively stable over the past ten years. The parkmanager of Funland, Janet Lieberman, recently shared with Fatima aproposal to replace one of their older rides with a new rollercoaster, a hybrid steel and wood roller coaster with a 90 degree,200 foot drop and three inversions. The proposal indicated that theride would cost $8,000,000 with an estimated life of 20 years. Inaddition, this new style of coaster would require additionalmaintenance and insurance, costing $125,000 each year. However, itprojected that this new attraction would boost attendance, earningthe park an additional $1,190,000 per year in revenues. Janetultimately decided not to invest in this new attraction. Fatima(doing a quick mental calculation) saw that the investment had apayback period of eight years—much shorter than the life of theroller coaster—and is perplexed at Janet’s decision.
The second dilemma concerns the Waterworld park. Waterworld isan indoor water park, operating year-round. Run by park managerDavid Copperfield, Waterworld was built in 2016 and has increasedattendance by 20% every year since. David recently sent you anemail complaining that, based on the current bonus payout schedule,Janet Lieberman’s bonus last year was significantly higher thanhis. He points to the increasing attendance, and says that his parkis being punished for having opened so recently (his park assetsare much more recent than the roller coasters at Funland). Hecurrently has an employment offer from another company at the samebase pay rate, which he says he will accept if his performance isnot appropriately acknowledged. Fatima needs to look at therelative performance across parks to determine how to proceed withDavid.
Central Treetops includes a high ropes course and has a seriesof ziplines that criss-cross over the Chippewa River. For manyyears, it was a popular venue for corporate team-buildingactivities, so it is equipped with a main indoor facility withcafeteria and overnight guest rooms. This park has lost popularityin 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 decidewhether to close it - permanently. Included in the ‘Fixed COGS’ forTreetops is a $86,000 mortgage payment on the land and9,351,510closed. Incidentally, you recently had a conversation withthe regional head of the YMCA, who would like to open a summer campin the central Michigan region. If you decided to close Treetops,you are fairly certain that you could lease that land to the YMCAfor $250,000 annually.
A partial report of this year’s financial results for CentralAdventures shows the following:
| Funland | Waterworld | Treetops |
Sales | $59,460,690 | $10,913,500 | $1,965,600 |
Fixed COGS | $10,351,870 | $4,284,530 | $170,430 |
Variable COGS | $39,757,310 | $2,220,695 | $746,928 |
Selling and administrative costs | $3,259,520 | $944,620 | $231,900 |
Average operating assets | $21,014,000 | $13,452,000 | $420,000 |
# of tickets sold | 1,564,755 | 419,750 | 30,240 |
# of employees | 540 | 200 | 32 |
The ‘Selling and administrative costs’ are all incurred directlyby each park, and are determined at the beginning of each year(that is, they do not change with the number of tickets sold). Inaddition to the information above, there are $2,542,920 incorporate costs, which are currently allocated evenly between thethree parks. These costs are primarily due to employee benefitscosts, which are billed at the corporate level. If the Treetopspark is closed, the allocated corporate costs would decrease by$12,000. Central Adventures has a cost of capital of 12 percent(and Fatima uses the cost of capital as their required rate ofreturn) and are subject to 18% income taxes.
Fatima needs to evaluate this year’s performance results beforeshe can make any decisions. Is David’s complaint about theperformance evaluation metrics valid? Is that also affectingmanagement decisions in the form of Janet’s rejection of theproposed new rollercoaster? And is the company better off withoutTreetops? She sets off to the company accountant’s office to helpget some answers.
Required:
Write your response in the form of a 1-2 page memo to FatimaHopkins, from the perspective of the company accountant. Be sure toinclude all your financial analyses, clearly showing yourcalculations, to support your conclusions. Be sure to include thefollowing points in your memo, and provide the appropriatefinancial analysis(es) to support your conclusions.
a. Create asegmented income statement for Central Adventures.
b. Calculatethe current annual ROI, residual income and EVA for the threeparks.
c. Evaluate JanetLieberman’s (the Funland park manager) decision. Explain why itwas/was not in Central Adventure’s overall best interest forFunland to reject the new rollercoaster.
