Wayside Case

Topics: Rate of return, Investment, Net present value Pages: 8 (2839 words) Published: November 6, 2011

2. Company Analysis
Wayside Inns was formed in 1980 as the successor to United Motels Enterprises, a company that operated several franchised motels under licensing agreements from two national chains. Wayside has been experiencing brisk business and is currently operating at near full capacity. To capture more business Wayside is considering a 40-room expansion for the motel. We shall evaluate the company using a SWOT analysis. Threats

- Competitors are expected to expand
- New customers may get shifted to other competitors due to lack of space in Wayside

3. Evaluation of the Proposed Investment
It is provided in exhibit 3 of the case that Wayside turned away an average of 9,181 customers in a year. If Wayside were to expand, these turnaway would generate additional revenue to the company. Besides, as shown in the SWOT analysis, new customers may get shifted to other competitors and this puts Wayside at a disadvantage. Nonetheless, the increase in revenue for the company will not serve as a good reason for the company to expand. It all depends on the returns with respect to the capital invested. Here we shall look at 1) return on investment (ROI) and 2) internal rate of return (IRR). 1. Return on Investment

Indicator| Current| Upon expansion|
ROI| 27.06%| 24.25%|

At first sight, we will realize that upon expansion, the return on investment of the company immediately drops by 2.81% and this may seem like a bad investment. However, we need to delve deeper to decide if ROI is a good indicator. ROI measures the net income over the total investment. One problem with ROI is that it will increase when capital assets depreciate. The ROI in the first year may be lower but thereafter it will increase, rendering this indicator ineffective to determine if they should take on the project. Another point to note is that investments that are above the company’s cost of capital should be undertaken as it adds value to the company. However, by using ROI the company may reject investments that are above the cost of capital if it reduces ROI. 2. Internal rate of return

We shall compare the IRR between not taking on the investments and taking on the investment. For simplicity, the cash flow for each period would be the operating income and we assume the cash flow would be in perpetuity. For the cash flow after expansion, we assumed that the cash flow will reach a terminal of $733,012. This is based on the maximum revenue that could be obtained for implementing 40 rooms taking into account the current capacity and the number of turnaways which are maxed at 40 per day based on the "Turnaway" table as shown in Exhibit 3(Appendi Indicator| Current| Upon expansion|

IRR| PV = CF/R – I0 = 397,504/R – 1,469,263.5K = 27.06% | PV = CF/R – I0 = 733,012/R – 2,573,789K= 28.47%|

We see from here that the internal rate of increased from 27.06% to 28.47%. This clearly indicates that this investment would bring additional value to the company and thus should be undertaken. 3. Layne Rembert’s concern

Layne Rembert is concerned if the ROI would decrease and the effects of the planned expansion on his incentive compensation and how his income for the year will be affected. Firstly, with regards to the ROI, it will indeed decrease from 27.06% to 24.25%. This is due to the increase in investment from $1,468,798 to $2,573,789 and that the increase in net income is less than proportionate, hence reducing ROI. However, the compensation package is made in such a way that the ROI bonus includes both the ROI portion and the Performance Factor portion. With the increase in the size of the investment, there is a jump in the value of the performance factor to the next investment tier, from $36,000 to $45,000. Therefore, the absolute amount of ROI bonus increased from $9,743 to $10,914. Furthermore, he has also not taken into account the sales volume bonus, where an increase in the revenue...
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • Cold Case Investigation Essay
  • Case Management Essay
  • Case Process Research Paper
  • Essay about Kensington Tablet Cases Make Holiday Shopping a Snap
  • Essay about Case Study Worksheet GE
  • Diversity Makes Good Business Case Essay
  • Making the Business Case: Multiple Choice Questions Essay
  • Just for Feet Audit Case 5-7 Essay

Become a StudyMode Member

Sign Up - It's Free