MAC Final Exam Part I. A. 1. Effect on after-tax cash inflow: a.

If the company will decide to donate the land, the companys after-tax cash inflow will indirectly increase by the amount equivalent to the tax deduction of $100,000. Tax shields, such as this tax deductions, are not inflows of cash per se, but are tax savings and are therefore deduction to the estimated total cash outflow for tax. In this way, the $100,000 tax deduction can therefore be regarded as an indirect cash inflow. b. If the company decides to sell the land at $100,000, there will be a net increase in after-tax cash inflow of $64,000 (see computation below). The total amount of the sale of the land ($100,000) will be included as part of the cash inflow. However, the tax to be paid on the gain from the sale of land amounting to $36,000 shall be deducted from the total proceeds in order to make it appear as an after-tax cash inflow.
Proceed from sale of land Less: Tax: Sales Value Less: Acquisition Value Gain from Sale of Land Multiply: Tax Rate Ner After-Tax Proceeds 100,000.00 100,000.00 10,000.00 90,000.00 40%

36,000.00 64,000.00

2. If the company decides to donate the land, the net income before tax will be increased to $10,090,000. The $10,000 acquisition value of the land becomes a loss on the part of the company since the disposition is trough a donation. However, the tax deduction of $100,000 will be deducted from the total tax expense (other than income tax) of the company, thus decreasing the total company expenses by the same amount. The net effect then is an increase in net income of $90,000, computed as follows:
Tax deduction from donation of land Less: Loss form donation of land Increase (Decrease) in Net Income 100,000.00 10,000.00 90,000.00

On the other hand, if the company decides to sell the land, the net income before tax will be increased to the same amount of $10,090,000. As computed in 1.b. above, the gain from sale of the land amounted to $90,000, computed as the difference of the sales value ($100,000) and its acquisition cost ($10,000). B. 1. The sales manager's complaint is justified. Product A has the largest net sales of the three products and under the allocation method used in the first year would, therefore, be charged the largest amount for advertising expense. However, the actual amount of advertising expense incurred on behalf of Product A, and hence the responsibility of the manager of Product A, is smaller than that incurred on behalf of Product B. 2. Product A should be charged $10,000 because that is the amount spent on behalf of Product A. It would be acceptable to charge Product A with an allocated portion of the institutional advertising, based on sales volume, but this amount should be separated from the $10,000 for which Product A is responsible. C. Sexy Swimsuit Company should not drop its line of womens beach robes. Assuming that the selling and administrative expenses are all variable, the line still contributes P52,668 to the total profit of the company. If Sexy Swimsuit Company will drop the womens beach robes line, then the company would lose the

contribution margin stated above. Also, the fixed cost of P100,548 assigned to the line will be absorbed by all other lines and would have to be continually paid by the company. Below is the computation to support the recommendation above, based on the assumption that no other fixed cost is assigned or incurred by the line except for the fixed overhead cost:
Revenue Less: Variable Costs: Production Costs: Cost of Goods Sold Less: Fixed Overhead Cost* Selling and Administrative Expenses Contribution Margin Less: Fixed Costs (Overhead) Net Income (Loss) * Fixed Overhead Cost Computation: Cost of Goods Sold Multiply: Percentage of Overhead Cost Total Overhead Cost Multiply: Percentage of Fixed Overhead Cost Fixed Overhead Cost 950,760.00

861,840.00 100,548.00

761,292.00 136,800.00

898,092.00 52,668.00 100,548.00 (47,880.00)

861,840.00 35% 301,644.00 1/3 100,548.00

Part II. Written Analysis of the Case I - Problem Statement What should the Olympic Car Wash, through Jacques Van Raemdonck, do so that the bonus pool may be granted to the car wash locations with better performance for the Spring quarter 2002? II Objectives To be able to: 1. assess the possibility of granting the bonus pool to the car wash locations within the limits of the provisions of the contract. 2. assess the possibility of adjusting the budgets for each of the location, using the Aalst Location as an example. 3. assess whether the Aalst location deserves to receive the grant of bonus pool for the Spring quarter 2002 in relation to its performance for the quarter. III Areas of Consideration 1. The performance evaluation Jacques Van Raemdonck conducts quarterly evaluation of the performance of each of the 30 locations of the car wash. The evaluation is performed by comparing the budgeted profit target against the actual profit of the location. This evaluation becomes the basis for which the bonus pool is granted to the personnel of each location. 2. The bonus contract The bonus contract provides for the manner by which the bonus is granted to the personnel of the Olympic Car Wash. According to the contract, $3,000 is being placed in the bonus pool of each location per quarter if such location was able to achieve its budgeted sales targets, plus the pool is augmented by $1 for every $10 of profit that the location exceeded from its targets. The contract also provides Jacques the right to make subjective adjustments for the effects of any factors he deemed beyond the control of the location personnel. 3. The weather condition during the Spring quarter of 2002 in Belgium Accordingly, the largest factor that Jacques have to consider is the weather condition in Belgium. Belgium experiences frequent rains throughout the year, and this causes the drop in the level of service sales volume for the car wash industry. During the Spring quarter 2002, the actual number of hours of rain exceeded the assumed level in the budget made by the company, thus all locations actual profit were far below the budgeted profit level. 4. The operating statistics of Aalst location The Aalst location of Olympic Car Wash operates daily at a 10-hour-per-day basis when it is not raining. For the Spring quarter 2002, the location generated sales of $124,080 and profit of $7,040 for 470 good weather hours at an average of 24 vehicles per good weather hour, generating an average revenue of $11 per vehicle serviced. The targets for the quarter is set at a sales of $184,000 and profit of $38,180 for 800 good weather hours at an average of 23 vehicles per good weather hour, generating an average of $10 per vehicle serviced.

IV Alternative Courses of Action ACA 1 Revise the targets for the quarter, adjusting the number of good weather hours and bad weather hours to the actual number of hours of weather for the quarter. Then, evaluation of the location performance will be based on the revised budget and not on the original budget. Under this alternative, the budget will be revised based on the actual number of good weather ours of the location.
Average number of vehicles washed per hour Average revenue per vehicle Working hours Revenue Variable expenses (50%) Fixed expenses Profit, Spring quarter 2002 Original Budget Revised Budget 23 23 $ 10.00 $ 10.00 800 470 $ 184,000.00 $ (92,000.00) (53,820.00) 38,180.00 $ Actual 24 11.00 470 124,080.00 (62,040.00) (55,000.00) 7,040.00

108,100.00 $ (54,050.00) (53,820.00) 230.00 $

Profit: Revised Profit Target: Variance Bonus pool Bonus augmentation ($6,810/10) Total bonus to be granted to the Aalst location

$ $ $ $ $ $

7,040.00 230.00 6,810.00 3,000.00 681.00 3,681.00

PROS CONS

More reliable estimates will be derived for the sales and net income figure. Evaluation of performance will be made on a more realistic basis than the original one. Bonus pools will be based on performances rather than on financial targets. Efficiency and effectiveness of the locations will be clearly identified. Process would require more time and effort for Jacques in computing for each locations new budget targets.

ACA 2 No revision is to be made on the budget; bonus pool is to be granted based on the variance on the locations number of good weather hours worked times the number of vehicles served per hour times the average service revenue per vehicle. The computation is to be made as follows:

Average number of vehicles washed per hour Average revenue per vehicle Working hours Revenue Variable expenses (50%) Fixed expenses Profit, Spring quarter 2002

Original Budget 23 $ 10.00 $ 800 $ 184,000.00 $ (92,000.00) (53,820.00) 38,180.00 $

Actual 24 11.00 470

Revised Actual 24 $ 11.00 800 211,200.00 (62,040.00) (55,000.00) 94,160.00

124,080.00 $ (62,040.00) (55,000.00) 7,040.00 $

Revised Profit (for evaluation purposes) Target Profit Variance Bonus pool Bonus augmentation ($55,980/10) Total bonus to be granted to the Aalst location

$ $ $ $ $ $

94,160.00 38,180.00 55,980.00 3,000.00 5,598.00 8,598.00

PROS The calculation of the basis for bonus will be easier. CONS The computational basis is unrealistic. Bonus pool becomes too high without proper justification. V Recommendation Based on the assessment made above, I recommend the alternative course of action 1, that is, Revise the targets for the quarter, adjusting the number of good weather hours and bad weather hours to the actual number of hours of weather for the quarter. Then, evaluation of the location performance will be based on the revised budget and not on the original budget. We can see that the benefits exceed the cost based on the pros and cons analysis of the alternative. The locations, particularly the Aalst location, would have exceeded the expected profit, had the weather been better. It is also clear that the average revenue was higher (probably because of bad whether anticipations and attempts of reaching the budgeted profit) and that the carwashes had performed better than expected in that perspective. Thus, it is indeed reasonable for Olympic Car Wash to grant the bonus pool as an acknowledgement of their hard work during this unfortunate quarter and as an incentive to work even harder over the summer where the weather would hopefully clear up. This would be a positive reinforcement, which motivates better than punishments. VI Potential Problem Analysis The alternative may pose some potential problems for the company. The alternative does not consider changing the system by which information will be gathered for estimating budget, thus possibility of large amount of errors and inaccuracy in setting targets will still continue. If the inaccuracy in the budgeting will continue, then, it will become a practice on the part of Jacques to always make consideration for the rainy season which, I believe, may not be regarded as force majeure. The company should then improve its financial planning activities by setting a more accurate budget and target levels for each location, considering the period on which heavy rains occur and other such environmental factors depending on the locations of the car wash.