Case 5-3: Royal Resort and Casino

Royal Resort and Casino (RRC), a publicly traded company, caters to affluent customers seeking
plush surroundings, high-quality food and entertainment, and all the "glitz" associated with the best
resorts and casinos. RRC consists of three divisions: hotel, gaming, and entertainment. The hotel divi-
sion manages the reservation system and lodging operations. Gaming consists of operations, security,
and junkets. Junkets offers complimentary air fare and lodging and entertainment at RRC for custom-
ers known to wager large sums. The entertainment division consists of restaurants, lounges, catering,
and shows. It books lounge shows and top-name entertainment in the theater. Although many of those
people attending the shows and eating in the restaurants stay at RRC, customers staying at other hotels
and casinos in the area also frequent RRC' s shows, restaurants, and gaming operations. The following
table disaggregates RRC's total EVA of $12 million into an EVA for each division:

ROYAL RESORT AND CASINO

EVA by Division
(Millions$)

Entertainment Hotel Gaming Totol

Adjusted accounting profits $ 5 $ 10 $30 $ 45

Invested Capital $40 $120 $60 $220
Weighted-average cost of capital 15% 15% 15% 15%
EVA $ (I) $ (8) $21 $ 12
= - --
Based on an analysis of similar companies, it is detennined that each division has the same weighted-
average cost of capital of 15 percent.
Across town from RRC is a city b.lock with three separate businesses: Big Horseshoe Slots &
Casino, Nell's Lounge and Grill, and Sunnyside Motel. These businesses serve a less affluent clientele.
Required:

a. Why does RRC operate as a single finn, whereas Big Horseshoe Slots, Nell's Lounge and
Grill, and Sunnyside Motel operate as three separate finns?
b. Describe some of the interdependencies that are likely to exist across RRC' s three divisions.
c. Describe some of the internal administrative devices, accounting-based measures, and/or
organizational structures that senior managers at RRC can use to control the interdepen-
dencies that you described in part (b).
d. Critically evaluate each of the "solutions" you proposed in Part (c).
 CRITICAL THINKING PROBLEM 2 (Zimmerman)

Golf World is a 1,000-room luxury resort with swimming pools, tennis courts, three golf
courses, and many other resort amenities.
The head golf course superintendent, Sandy Green, is responsible for all golf course
maintenance and conditioning. Green also has the final say as to whether a particular course is
open or closed due to weather conditions and whether players can rent motorized riding golf
carts for use on a particular course. If the course is very wet, the golf carts will damage the turf,
which Green’s maintenance crew will have to repair. Since she is out on the courses every
morning supervising the maintenance crews, she knows the condition of the courses.
Wiley Grimes is in charge of the golf cart rentals. His crew maintains the golf cart fleet of
over 200 carts, cleans them, puts oil and gas in them, and repairs minor damage. He also is
responsible for leasing the carts from the manufacturer, including the terms of the lease, the
number of carts to lease, and the choice of cart vendor. When guests arrive at the golf course to
play, they pay greens fees to play and a cart fee if they wish to use a cart. If they do not wish to
rent a cart, they pay only the greens fee and walk the course.
Grimes and Green manage separate profit centers. The golf cart profit center’s revenue is
composed of the fees collected from the carts. The golf course profit center’s revenue is from
the greens fees collected. When the results from April were reviewed, golf cart operating profits
were only 49 percent of budget. Wiley argued that the poor results were due to the unusually
heavy rains in April. He complained that there were several days when, though only a few areas
of the course were wet, the entire course was closed to carts because the grounds crew was too
busy to rope off these areas.
To better analyze the performance of the golf cart profit center, the controller’s office
recently implemented a flexible budget based on the number of cart rentals:

GOLF WORLD
Golf Cart Profit Center
Operating Results—April
Static Actual Variance from Flexible Variance from
Budget Results Static Budget Budget Flexible Budget
________________________________________________________________________________
Number of cart rentals 6,000 4,000 2,000 4,000 0
Revenues (@ $25/cart) $150,000 $100,000 $50,000U $100,000 0
Labor (fixed cost) 7,000 7,200 200U 7,000 200U
Gas and oil
(@ $1/rental) 6,000 4,900 1,100F 4,000 900U
Cart lease (fixed cost) 40,000 40,000 0 40,000 0___
Operating profit $ 97,000 $ 47,900 $49,100U $ 49,000 $1,100U

NOTE: F = Favorable; U = Unfavorable

REQUIRED

a. Evaluate the performance of the golf cart profit center for the month of April.
b. What are the advantages and disadvantages of the controller’s new budgeting system?
c. What additional recommendations would you make regarding the operations of Golf World?
Case 5-2: Executive Inn
Sarah Adams manages Executive Inn of Toronto, a 200-room facility that rents furnished suites to
executives by the month. The market is for people relocating to Toronto and waiting for permanent
housing. Adams' s compensation contains a fixed component and a bonus based on the net cash flows
from operations. She seeks to maximize her compensation. Adams likes her job and has learned a lot,
but she expects to be working for a financial institution within five years.
Adams's occupancy rate is running at 98 percent, and she is considering a $10 million expan-
sion of the present building to add more rental units. She has very good private knowledge of the
future cash flows. In year 1, they will be $2 million and will decline $100,000 a year. The following
table summarizes the expa~sion's cash flows:

Year Net Cash Flow (Millions) Year Net Cash Flow (Millions)

0 $(10.0) 6 1.5
1 2.0 7 1.4
2 1.9 8 1.3
3 1.8 9 1.2
4 1.7 10 1.1
5 1.6
Based on the preceding data, Adams prepares a discounted cash flow analysis of .the addition, which
is contained in the following rep6rt: '-·

Net Cash Present

Flow Discount Value of
Year (Millions) Factor Cash Flow
0 $(10.0) 1.000 $(10.00)
1 2.0 0.893. 1.79
2 . 1.9 0.797 1.51
3 1.8 0.712 1.28
4 1.7 0.636 1.08
5 1.6 0.567 0.91
6 1.5 0.507 0.76
7 1.4 0.452 0.63
8 1.3 0.404 0.53
9 1.2 0.361 0.43
10 1.1 0.322 0.35
Total
---
$ (0.73)

The discount factors are based o~ a weighted-average cost of capital of 12 percent, which ac-
curately reflects the inn's nondiversifiable risk.
'Adams's boss, Kathy Judson, manages the Inn Division of Comfort Inc., which has 15 proper-
ties located around North America including Executive ~nn of Toronto. Judson does not have the
detailed knowledge of the Toronto ho.tel/rental market as Adams does. Her general knowledge is· not
as detailed or as accurate as Adams's. (For the following questions, ignore taxes.)
Required:

a. . The Inn Division of Comfort Inc. h<is a very crude accounting system that does not assign
the depreciation of particular inns to individual managers. As a re~ult, Adams's annual net
cash flow statement is based on the operating revenues less operating expenses. Neither
the cost of expansion nor depreciation on expanding hfil- inn is charged to her operating
statement. Given the facts provided so far, what decision do you expect her to .make ·
regarding building the $10 million addition? Explain why.
b. Adams prepares the. following report for Judson to justify the expansion project:

Net Cash Present

Flow Discount Value of
Year (Millions) Factor Cash Flow
0 $(10.0) 1.000 $(10.00)
I 2.0 0.893 1.79
2 1.9 0.797 1.51
3 1.9 0.712 1.35
4 1.8 0.636 1.14
5 1.8 0.567 1.02
6 1.8 0.507 0.91
7 1.8 0.452 0.81
8 1.8 0.404 0.73
9 1.7 0.361 0.61
10 1.7 0.322 0.55
Net present value $ 0.42
--
 Judson realizes that Adams's projected cash flows are most likely optimistic, but she
does not lmow how optimistic or even whether or not the project is a positive net present
value project. She d6Cides to change Adams's performance measure used in computing
her bonus. Adams's compensation will be based on residual income (EVA). Judson also
changes the accounting system to track asset expansion and depreciation on the expansion.
Adams's profits from operations will now be charged for straight-line depreciation of the
expansion using a 10-year life (assume a zero salvage value). Calculate Adams's expected
residual income from the expansion for each of the next 10 years.
c. Based on your calculations in (b), will Adams propose the expansion project? Explain why.
d. Instead of using residual income as Adams's perlormance measure in (b), Judson uses net
cash flows from operations less straight-line depreciation. Will Adams seek to undertake
the expansion? Explain why.
e. Reconcile any differences in your answers for (c) and (d).