Question

Big Spenders Inc. has been working on diversifying its portfolio of investments and requires accounting advice for a decision between two car cleaning and detailing companies. Your responsibility is to perform a comparative analysis of the profitability of two potential equity investments. Your engagement manager on this job has given you a brief background on the operations of the two companies:

Auto Wash Bot Ltd. (AWBL) has recently completed the research and development of a new touch screen app for all mobile devices. This new technology is both more user friendly than the current technology on the market. Auto Wash Bot Ltd has just signed a major contract to provide the Auto Wash Bot terminal to a major producer of mobile devices. The founder of the business would like to sell a 50% interest in the business for $100,000 in order to finance further expansion of operations.

Popeye’s Muscle Wash Ltd (PMWL) is a self-service, coin operated car wash located in a busy residential area. The company provides all of the services of a typical car wash, including soap, wax, vacuuming as well as pressure washing. PMWL has been long established and enjoys the loyalty and repeat business of many local residents. The current owner is getting up in age and would like to sell 100% ownership interest in the business for $100,000 to pursue retirement. The current year’s income statement is consistent with prior years.

One of the first tasks in the analysis of the potential equity acquisition is an assessment of each company’s current and future profitability. Your manager has provided you with copies of each company’s income statement (see below). Next, you are to calculate the expected return on the investment for each company. You have been asked to discuss any other issues that you believe are relevant to the investment decision.

The Consulting Manager would like you to prepare the report and have it on his desk for review first thing tomorrow morning. Once reviewed, this report will be submitted to Big Spenders Inc. in order to support their decision.

Auto Wash Bot Ltd.

Income Statement

For the Year Ended December 31, 2015

Revenue

$375,000

Cost of Goods Sold

86,250

     Gross Profit

288,750

Other Expenses

   Advertising

35,400

   Office Expense

22,750

   Research

195,000

   Wages and Salaries

40,000

      Total Other Expenses

293,150

Income Before Taxes

(4,400)

   Income Tax

0

Net Income

$(4,400)

Popeye’s Muscle Wash Ltd

Income Statement

For the Year Ended December 31, 2015

Revenue

$375,000

Cost of Goods Sold

163,125

     Gross Profit

211,875

Other Expenses

   Advertising

5,200

   Office Expense

17,400

   Repairs and Maintenance

85,000

   Wages and Salaries

50,000

      Total Other Expenses

157,600

Income Before Taxes

54,275

   Income Tax*

8,413

Net Income

$45,862

                                            

*Tax rate of 15.5% used.

Answer 1

By analysing the above senario , I would recommend to chose company

Popeye's Muscle Wash Ltd.

the reasons are as follows

1. Tax paid by 2. company is according to the rate that is 15.5% whereas company 1. doesn't pay any taxes and create Tax liablity for future and owers the interest of investors

2.The revenue of both the companies is same but COGS of 2. is higher than 1.

3. The NET income of 2. is higher than 1. ( keeping it in mind that it paid taxes also )

4,.PMWL enjoys Brand value, Goodwill and loyalty of customers

5. It is also located in the busy market

Thus by considering these points it would be better to invest in PMWL rather than AWBL