Exam 20: Management Compensation, Business Analysis, and Business Valuation

The Harrison Bicycle Company had the following operating results for 2018-2019. In addition, the company paid dividends in both 2018 and 2019 of $80,000 per year and made capital expenditures in both years of $230,000 per year. The company's stock price in 2018 was $14.20 and $12.50 in 2019. Also in 2019, the industry average earnings multiple for the bicycle industry was 8 and the free cash flow and sales multiples were 16 and 1.35, respectively. The company is publicly owned and has 1,400,000 shares of outstanding stock at the end of 2019. $\text { Balance Sheet, Dec 31, }$ 2019 2018 Cash \ 267,000 \ 100,000 Accounts Receivable \ 525,000 \ 400,000 Inventory \ 450,000 \ 300,000 Total Current Assets \ 1,242,000 \ 800,000 Long-lived Assets 1,205,000 1,100,000 Total Assets \2 ,447,000 \1 ,900,000 Current Liabilities \5 00,000 \5 00 Long-term Debt 600,000 500,000 Shareholder Equity 1,347,000 1,100,000 Total Debt and Equity \2 ,447,000 \1 ,900,000 $\text { Income Statement, for year ended Dec 31, }$ 2019 2018 Sales \ 6,250,000 \ 5,450,000 Cost of Sales 5,125,000 4,400,000 Gross Margin 1,125,000 1,050,000 Operating Expenses 580,000 550,000 Operating Income 545,000 500,000 Taxes 218,000 200,000 Net Income \3 27,000 \3 00,000 Cash Flow from Operations 2019 2018 Net Income \ 327,000 \ 300,000 Plus Depreciation Expense 125,000 125,000 + Decrease (-inc) in AccRec. and Inv. 7(275,000) - + Increase (-dec) in Cur. Liabl. 200,000 - Cash Flow from Operations \3 77,000 \4 25,000 Return on equity for 2019 is (rounded):

EVA is the acronym for:

Wilson & Associates is a medium-size marketing organization specializing in professional promotion and publicity services. The firm's top management believes that it provides quality service as evidenced by the high level of customer satisfaction. The organization consists of three departments: print media, audio media, and visual media, each of which has a senior director in charge. The company employs 80 clerical staff who are paid on an hourly basis and 30 professional staff who are salaried. A large majority of the employees have an excellent rating in their job skills, and all employees demonstrate above average performance in their job responsibilities. The employees take pride in their achievements, and morale is very good. Salary ranges are established for different job classifications within the clerical staff (i.e., clerk, clerk typist, secretary, and administrative assistant) and the professional staff (i.e., analyst, manager, and director). A fixed-rate structure is used for all salaries. The company offers no commissions because it does not want its professional staff applying undue sales pressure on its customers. Company management is proud that it does not have to resort to a salary plus commission structure for its professionals to generate sales. Employees are recognized for superior performances through salary increases and promotions. Management believes that salary increases should be based on merit, and open positions are filled from within whenever possible. Top management contends that highly skilled and motivated employees will improve productivity if they are rewarded with annual merit pay raises and if promotions are based on performance. Top management announced in November 2018 that the amount available for pay increases in 2019 would be 10 percent of the actual total salary expenditures for 2018. All salary increases would be effective January 1, 2019. The print media department consists of 20 clerical and eight professional employees on January 1, 2018. Six clerical employees were added during the year at the rate of about one every two months. Two professionals were added, one on March 1 and one on August 1. Three employees were promoted during the year: two secretaries to administrative assistants and one manager to director. The total actual salary expense for the department without regard for employee benefits and employer tax contributions was $548,000. Therefore, the total amount allocated for wage increases for the print media department in 2019 is designated to be $54,800. Shortly after the merit pay program was announced, the print media department employees received their year-end evaluation conducted by the employee's supervisor. The senior director met with each supervisor, received all performance reports, and then announced the merit pay increase for each employee. Upon completion of this entire process, several employees complained individually about the inequities of the merit pay program. The senior director was concerned about the employee discontent because the people complaining were some of the highest achievers on the staff. They tended to be at the lower classification levels and were relatively new employees, having been with the company for one to two years. The individuals showed potential and were highly motivated, often working extra hours and assuming additional responsibilities. The new employees' behavior differed slightly from the employees who had been with the department for a longer period of time. Although highly skilled and competent in their jobs, the veteran employees tended to be reluctant to accept additional responsibility or to work extra hours on a regular basis. Required: 1) Review Wilson and Associates' wage and compensation plan. a. Identify and discuss the general strengths of the wage and compensation plan. b. Identify and explain the shortcomings in the administration of the merit pay increases that are to become effective in 2019, and discuss what effect these shortcomings could have on the group of discontent employees in the print media department. 2) Explain how this compensation program should be revised, if at all.

There is a common concern today that executive compensation in the U.S.is:

The Harrison Bicycle Company had the following operating results for 2018-2019. In addition, the company paid dividends in both 2018 and 2019 of $80,000 per year and made capital expenditures in both years of $230,000 per year. The company's stock price in 2018 was $14.20 and $12.50 in 2019. Also in 2019, the industry average earnings multiple for the bicycle industry was 8 and the free cash flow and sales multiples were 16 and 1.35, respectively. The company is publicly owned and has 1,400,000 shares of outstanding stock at the end of 2019. $\text { Balance Sheet, Dec 31, }$ 2019 2018 Cash \ 267,000 \ 100,000 Accounts Receivable \ 525,000 \ 400,000 Inventory \ 450,000 \ 300,000 Total Current Assets \ 1,242,000 \ 800,000 Long-lived Assets 1,205,000 1,100,000 Total Assets \2 ,447,000 \1 ,900,000 Current Liabilities \5 00,000 \5 00 Long-term Debt 600,000 500,000 Shareholder Equity 1,347,000 1,100,000 Total Debt and Equity \2 ,447,000 \1 ,900,000 $\text { Income Statement, for year ended Dec 31, }$ 2019 2018 Sales \ 6,250,000 \ 5,450,000 Cost of Sales 5,125,000 4,400,000 Gross Margin 1,125,000 1,050,000 Operating Expenses 580,000 550,000 Operating Income 545,000 500,000 Taxes 218,000 200,000 Net Income \3 27,000 \3 00,000 Cash Flow from Operations 2019 2018 Net Income \ 327,000 \ 300,000 Plus Depreciation Expense 125,000 125,000 + Decrease (-inc) in AccRec. and Inv. 7(275,000) - + Increase (-dec) in Cur. Liabl. 200,000 - Cash Flow from Operations \3 77,000 \4 25,000 The gross margin percentage for 2019 is (rounded):

In developing compensation plans, the management accountant works to achieve fairness by making the plan:

The stock option form of bonus payments to managers usually:

The ideal compensation plan would make all company contributions to the plan immediately tax-deductible and all tax consequences for managers:

Which of the following types of compensation does not provide a deduction to the firm for tax purposes?

Jackson Manufacturing has the following operating results for 2019. $\text { Balance Sheet, Dec 31, }$ 2019 2018 Cash \ 489,350 \ 125,000 Accounts Receivable \ 315,000 \ 400,000 Inventory \ 225,000 \ 375,000 Total Current Assets \ 1,029,350 \ 900,000 Long-lived Assets 2,345,000 2,350,000 Total Assets \3 ,374,350 \3 ,250,000 Current Liabilities \2 85,000 \3 15,000 Long-term Debt 600,000 800,000 Shareholder Equity 2,489,350 2,135,000 Total Debt and Equity \3 ,374,350 \3 ,250,000 $\text { Income Statement, for year ended Dec } 31 \text {, }$ 2019 2018 Sales \ 3,775,000 \ 3,555,000 Cost of Sales 2,554,000 2,445,000 Gross Margin 1,221,000 1,110,000 Operating Expenses 522,000 445,000 Operating Income 699,000 665,000 Taxes 244,650 232,750 Net Income \4 54,350 \4 32,250 Cash Flow From Operations 2019 2018 Net Income \ 454,350 \ 432,250 Plus Depreciation Expense 50,000 50,000 + Decrease (-inc) in AccRec and Inv. 235,000 - +Increase (-dec) in Cur. Liabl. (30,000) - Cash Flow from Operations \7 09,350 \4 82,250 In addition, the company paid dividends in both 2018 and 2019 of $100,000 per year and made capital expenditures in both years of $45,000 per year. The company's stock price in 2018 was $10 and $12 in 2019. The industry average earnings multiple for the industry was 10 in 2019 and the free cash flow and sales multiples were 20 and 2, respectively. The company is publicly owned and has 1,050,000 shares of outstanding stock at the end of 2019. The industry average ratios for Jackson's industry were as follows in the most recent year. Exhibit A: Industry Ratios for Jackson Manufacturing Accounts Receivable Turnover 11.10 Inventory Turnover 11.30 Current Ratio 2.80 Quick Ratio 2.00 Cash Flow from Operations Ratio 1.20 Free Cash Flow Ratio 1.10 Gross Margin Percentage 30.0\% Return on Assets (Net Book Value) 20.0\% Return on Equity 30.0\% Required: 1. Calculate the ratios In Exhibit A for Jackson Company for 2019, group them by category (liquidity, profitability) and develop a brief overview for the liquidity and profitability of Jackson Manufacturing at the end of 2019. 2. Complete a Business Valuation for Jackson Manufacturing based on 2019 financial statement information.

A deferred bonus can consist of:

Lack of controllability is a disadvantage associated with which bonus compensation base relative to compensation objectives?

Ruth's Chris Steak House is a chain of restaurants that began 43 years ago as a single location in New Orleans and has grown to more than 90 restaurants. RCSH went public, with an initial public offering of stock (IPO) in August 2005. A question at the time of the IPO was how to value the company, given available information. Ruth's had sales of $192.2 million in 2004, earnings of $23.3 million, and net debt less cash of $117 million. One analyst chose to use the enterprise value of comparable companies, noting that Smith and Wollensky Restaurant Group (another chain of steak restaurants) had a ratio of enterprise value to sales of 70 percent. Another restaurant chain, Morton's, had recently gone private and, in the last year as a public company, had an enterprise ratio to sales of 80 percent. Required: Develop an estimate of the market capitalization (market value of equity) of RCSH in August 2005 and explain your reasoning.

Which one of the following refers to the firm's ability to pay its current operating expenses and maturing debt?

Axeltronics is a manufacturer of electronic components and accessories with total assets of $20,000,000. Selected financial ratios for Axeltronics and the industry averages for firms of similar size are presented below. Axeltronics 2013 Industry Average 2016 2018 2019 Current ratio 2.09 2.27 2.51 2.24 Quick ratio 1.15 1.12 1.19 1.22 Inventory turnover 2.40 2.18 2.02 3.50 Return on Equity 0.14 0.15 0.17 0.11 Axeltronics is being reviewed by several entities whose interests vary, and the company's financial ratios are a part of the data being considered. Each of the parties listed below must recommend an action based on its evaluation of Axeltronics' financial position. ● Mid Coastal Bank. The bank is processing Axeltronics' application for the new five-year term note. Mid Coastal has been Axeltronics' banker for several years, but must re-evaluate the company's financial position for each major transaction. ● Ozawa Company. Ozawa is a new supplier to Axeltronics, and must decide on the appropriate credit terms to extend to the company. ● Drucker & Denon. A brokerage firm specializing in the stock of electronics firms that are sold over-the-counter, Drucker & Denon must decide if it will include Axeltronics in a new fund being established for sale to Drucker & Denon's clients. ● Working Capital Management Committee. This is a committee of Axeltronics' management personnel chaired by the chief operating officer. The committee is charged with the responsibility of periodically reviewing the company's working capital position, comparing actual data against budgets, and recommending changes in strategy as needed. Required: (1) Describe the analytical use of each of the four ratios presented above. (2) For each of the four entities described above, identify one or two financial ratios, from those ratios presented, that would be most valuable as a basis for its decision regarding Axeltronics. (3) Discuss what the financial ratios presented in the question reveal about Axeltronics. Support your answer by citing specific ratio levels and trends as well as the interrelationships between these ratios.

The King Mattress Company had the following operating results for 2018-2019. In addition, the company paid dividends in both 2018 and 2019 of $60,000 per year and made capital expenditures in both years of $30,000 per year. The company's stock price in 2018 was $8 and $7 in 2019. The industry average earnings multiple for the mattress industry was 9 in 2019 and the free cash flow and sales multiples were 18 and 1.5, respectively. The company is publicly owned and has 1,200,000 shares of outstanding stock at the end of 2019. $\text { Balance Sheet, Dec 31, }$ 2019 2018 Cash \ 340,000 \ 100,000 Accounts Receivable \ 350,000 \ 400,000 Inventory \ 250,000 \ 300,000 Total Current Assets \9 40,000 \8 00,000 Long-lived Assets 1,080,000 1,100,000 Total Assets \2 ,020,000 \1 ,900,000 Current Liabilities \2 00,000 \3 00,000 Long-term Debt 600,000 500,000 Shareholder Equity 1,220,000 1,100,000 Total Debt and Equity \2 ,020,000 \1 ,900,000 $\text { Income Statement, for year ended Dec } 31 \text {, }$ 2019 2018 Sales \ 4,750,000 \ 4,500,000 Cost of Sales 4,100,000 4,000,000 Gross Margin 650,000 500,000 Operating Expenses 350,000 400,000 Operating Income 300,000 100,000 Taxes 120,000 40,000 Net Income \1 80,000 \6 0,000 Cash Flow from Operations 2019 2018 Net Income \ 180,000 \ 60.000 Plus Depreciation Expense 50,000 50,000 + Decrease (-inc) in AccRec. and Inv. 100,000 - + Increase (-dec) in Cur. Liabl. (100,000) - Cash Flow from Operations \2 30,000 \1 10,000 Return on assets for 2019 is (rounded):

The commonly used approaches for business valuation include: Profitability Financial \&Efficiency Discounted Analysis Analysis Cash Flow A) Yes Yes No B) Yes No No C) No Yes Yes D) No No Yes E) Yes No Yes

The profit multiplier used by service firms measures:

Which of the following is a bonus payment option?

Household Brands Inc. (HBI) manufactures household goods in the United States. The company made two acquisitions in previous years to diversify their product lines. In 2011, HBI acquired cosmetics and consumer electronics companies. HBI is now, in 2020, comprised of three divisions: cosmetics, household, and consumer electronics. The following information (in thousands of dollars) presents operating revenues, operating income, and invested assets of the company over the last three years: Revenue Operating Income Assets Cosmetics 2018 \ 24,500 \ 2,300 \ 10,000 2019 22,500 1,900 10,000 2020 19,600 1,800 9,500 Household 2018 17,400 1,300 7,500 2019 15,300 1,100 8,000 2020 12,500 900 6,500 Electronics 2018 13,500 1,500 4,500 2019 9,500 1,100 4,500 2020 8,700 1,050 4,300 Household Brands Total 2018 55,400 5,100 22,000 2019 47,300 4,100 22,500 2020 40,800 3,750 20,300 The current compensation package is an annual bonus award. The senior executives share in the bonus pool. The pool is calculated as 20% of the annual residual income of the company. The residual income is defined as operating income minus a cost of capital charge of 15% of invested assets. Round all calculations to two significant digits. The total amount of the bonus pool for 2020 is: