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Financial Analysis and Decision-Making in Business: Evaluating Loyalty Programs, Cost of Capital, and Valuation Models

Evaluation of financial decision-making strategies in business.

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    Financial Analysis and Decision-Making in Business: Evaluating Loyalty Programs, Cost of Capital, and Valuation Models, page 1Financial Analysis and Decision-Making in Business: Evaluating Loyalty Programs, Costof Capital, and Valuation Models1.AMCE, Inc. is considering adding a loyalty program in which its customers can earn pointsfor discounts in lieu of runningstorewide promotions. Additionally, ACME would collectinformation on its customers’ shopping transactions, which allow ACME to craftindividualized promotions.Currently ACME has $225million in annual sales generating a profit margin of3.0percenton sales and an asset turnover of4.5. ACME’s marketing group believes the loyalty programwould increase sales by $20million with an additional investment in working capital of $2.5million to support the increased sales. Costs to run the loyalty program would reduce profitmargin to2.8percent.Based solely on the above financial consideration, explain whether you would recommendmanagement consider adding this new program. (5points)[Hint: RNOA Analysis]Ans. Given Information:Current Sales = $225 millionProfit = 225million x 3% = $6,750,000Assets Turnover = 4.5Assets = Sales / Assets Turnover = 225million / 4.5 = $50,000,000If Loyalty Program implemented:Sales = $245 millionProfit = 245million x 2.8% = $6,860,000Working Capital =Present Working Capital + $2.5 millionWe have no Information about Present level of Working Capital so we can assume it anyNumber, say, 10,000,000.According to RNOA (Return on Net Operating Assets) = Net Profit / Assets + WorkingCapitalRNOA gives indication of financial performance of Company with respect of Assets andWorking Capital employed.RNOA before implementation of Loyalty Program: 6,750,000 / 50,000,000 + 10,000,000RNOA = 11.25% It means Company is earning at the rate of 11.25% on the Assets andWorking Capital employed by it.RNOA after implementation of Loyalty Program: 6,860,000 / 50,000,000 + 12,500,000RNOA = 10.98% It means Company is earning at the rate of 10.98% on the Assets andWorking Capital employed by it.

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    Financial Analysis and Decision-Making in Business: Evaluating Loyalty Programs, Cost of Capital, and Valuation Models, page 2

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