Miami Valley Architects Inc.

CASE 1
Miami Valley Architects Inc. provides a wide range of engineering and architectural consulting services through its three branch offices in Columbus, Cincinnati, and Dayton. The company allocates resources and bonuses to the three branches based on the net income reported for the period. The following presents the results of 2020 performance ($ in thousands).

                    Columbus    Cincinnati  Dayton      Total

Sales $1,500 $1,419 $1,067 $3,986
Less: Direct labor (382) (317) (317) (1,016)
Direct material (281) (421) (185) (887)
Overhead (710) (589) (589) (1,888)
Net income $ 127 $ 92 $ (24) $ (195)

Overhead items are accumulated in one overhead pool and allocated to the branches based on direct labor dollars. For 2020, this predetermined overhead rate was $1.859 for every direct labor dollar incurred by an office. The overhead pool includes rent, depreciation, taxes, and so on, regardless of which office incurred the expense. This method of accumulating costs forces the offices to absorb a portion of the overhead incurred by other offices.
Management is concerned with the results of the 2020 performance reports. During a review of the overhead, it became apparent that many items of overhead are not correlated to the movement in direct labor dollars as previously assumed. Management decided that applying overhead based on activity-based costing and direct tracing, where possible, should provide a more accurate picture of the profitability of each branch.
An analysis of the overhead revealed that the following dollars for rent, utilities, depreciation, taxes, and so on, could be traced directly to the office that incurred the overhead ($ in thousands).

                    Columbus    Cincinnati  Dayton      Total
        Direct overhead         $180       $270       $177       $627

Activity pools and activity drivers were determined from the accounting records and staff surveys as follows:

# OF ACTIVITIES BY LOCATION

Activity Pools Activity Driver Columbus Cincinnati Dayton
General Administration $ 409,000 Direct Labor $ 382,413 317,086 317,188
Project Costing 48,000 # of Timesheet Entries 6,000 3,800 3,500
Accounts Payable/Receiving 139,000 # of Vendor Invoices 1,020 850 400
Accounts Receivable 47,000 # of Client Invoices 588 444 96
Payroll/Mail Sort & Delivery 30,000 # of Employees 23 26 18
Personnel Recruiting 38,000 # of New Hires 8 4 7
Employee Insurance Processing 14,000 Insurance Claims Filed 230 260 180
Proposals 139,000 # of Proposals 200 250 60
Sales Meetings/Sales Aids 202,000 Contracted Sales 1,824,439 1,399,617 571,208
Shipping 24,000 # of Projects 99 124 30
Ordering 48,000 # of Purchase Orders 135 110 80
Duplicating Costs 46,000 # of Copies Duplicated 162,500 146,250 65,000
Blueprinting 77,000 # of Blueprints 39,000 31,200 16,000
$1,261,000

Required (all weight equal to the Case’s final mark_

1. What overhead costs should be assigned to each branch based on activity-based costing concepts?
2. What is the contribution of each branch before subtracting the results obtained in part (a)?
3. What is the profitability of each branch office using activity-based costing?
4. Evaluate the concerns of management regarding the traditional costing technique currently used
5. Provide a critical and argued discussion on the pros and cons of activity-based costing vs. traditional costing approaches.
    
   CASE 2
   The following Income Statement comes from the fiscal year 2020 of DPC college (all amounts in $). Revenues from tuition fees 440,000 Minus Cost of services provided (70,116)
   Gross profit 369,884
   Minus Operating expenses (303,600)
   Profit before taxes 66,284

So far, DPC has been renting its facilities (building, equipment etc.) for $60,000 annually. This expense is included in “Operating expenses” above. DPC’s owner could acquire now, i.e. 01/01/2021, all equipment (instead of renting it) for $600,000. Further assume the following:
i. Useful life of building and equipment = 50 years; Salvage Value = 100000; Straight-line depreciation
ii. Corporate tax rate = 30%
iii. Net working capital = 20% of next year’s revenues
iv. Revenues are expected to increase 3% annually for the next 5 years
v. Costs and expenses except for depreciation and interest (if any) are expected to increase by 2% annually for the next 5 years
vi. DPC would apply a zero-payout dividend policy the next 5 years, i.e. retain all its earnings (if any)
vii. The acquisition would be financed as follows:
a. $500,000 with a new bond with 10 years maturity and 5% annual coupon rate. Similar bonds are discounted at 6% annually
b. The rest with new common stocks. DPC’s unlevered beta has been estimated 0.5. Floatation costs are 1% of stock price. Market annual return is 8%. Risk-free rate is 2%.
viii. The investment could be sold “as it is” for $700,000 after 5 years. “As it is” means that the buyer would pay $700,000 to DPC’s owner and receive all common stocks. Therefore, the $700,000 amount represents the net proceeds from the sale of investment. Any change in working capital because of the sale of investment is included in the $700,000 amount, i.e. there would be no additional investment or release from working capital at the end of year 5.

Required (all weight equal to the Case’s final mark)

1. Prepare the pro-forma income statements for first 5 years and decide whether the investment must be approved based on the Accounting Rate of Return (ARR). Assume a threshold rate of 20%. Provide a critical and argued discussion on ARR’s pros and cons as investment appraisal technique.
2. Prepare the pro-forma cash budget for the first 5 years and decide whether the investment must be approved based on the Payback Period (PBP). Assume a threshold period of 4 years. Provide a critical and argued discussion on PBP’s pros and cons as investment appraisal technique.
3. Compute DPC’s Weighted Average Cost of Capital and evaluate the investment with the Net Present Value (NPV) and Internal Rate of Return (IRR) methods. Provide a critical and argued discussion on NPV’s and IRR’s pros and cons as investment appraisal techniques.
4. Provide a critical and argued discussion on the financing sources available (pros and cons), comment on DPC’s optimum capital structure, and advise DPC’s owner on his/her action.