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Case: America Online Inc

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Introduction

Case: America Online Inc., Topic: Strategy Analysis Prior to 1995, AOL was so successful in the commercial online industry relative to its competitors CompuServe and Prodigy primarily because of its pricing rate structure which was the easiest for customers to understand and plan for ahead of time. CompuServe and Prodigy offered the same pricing as AOL for its standard service, but, charged additional fees for premium services and downloading which made it more difficult for customers to anticipate their monthly spending. The key changes taking changes taking place in the online industry in 1995 are the introduction of the Microsoft network and the coming of use of the Internet World Wide Web which offered alternative channels to content providers that provided more control over their offerings and potentially higher revenues. Microsoft Network took only a 30% commission fee (versus 80% taken by AOL from its content providers' revenues) from its content providers and offered providers the option of choosing any format and font to display their content (versus the standard screen displays offered by AOL and its rivals). Also, the per-hour pricing policy offered by Microsoft was superior to AOL's. ...read more.

Middle

are much better when the costs are capitalized (See Appendix C.2). Expensing subscriber acquisition costs increases expenses in the income statement by $51,467 million and causes the operating income and net income to be much lower than if they were capitalized. The operating income and net income consists of loss of $19,294 million and $33,647 respectively in the case of capitalization versus a loss of $70,131 million and $84,484 respectively in the case of expensing (See Appendix B). However, there is a superior tax benefit if one were to expense - the differential tax benefit between the two approaches is $17,285 million (See Appendix C.3). Appendix A A.1 Case Discussion Questions 1. Prior to 1995, why was AOL so successful in the commercial online industry relative to its competitors CompuServe and Prodigy? 2. As of 1995, what are the key changes taking place in the commercial online industry? How are they likely to affect AOL's future prospects? 3. Was AOL's policy to capitalize subscriber acquisition costs justified prior to 1995? 4. Given the changes discussed in question 2, do you think AOL should change its accounting policy as of 1995? ...read more.

Conclusion

Value of Subscriber Acquisition Costs Asset = $406,464 M- $130,473 M = $275,991 Million Adjusted Book Value of Equity = Book Value of Equity - Value of Subscriber Acquisition Costs Asset = $217,944 M- $130,473 M = $87,471 Million Adjusted Book Value of Capital = Book Value of Capital - Value of Subscriber Acquisition Costs Asset = $239,754 M- $130,473 M = $109,281 Million Subscriber Acquisition Costs Capitalized Subscriber Acquisition Costs Expensed Return on Assets (ROA) (19,294)(1-.34)/406,464 = -3.13% (70,131)(1-.34)/ 275,991 = -17% Return on Equity (ROE) (33,647)/217,944 = -15.44% (84,484) /87,471 = -97% Return on Capital (ROC) (19,294)(1-.34)/ (21,810+217,944) = -5.31% (70,131)(1-.34)/109,281 = -42% C.3 Differential Tax Benefit Subscriber Acquisition Costs in 1995 = $111,761 million Amortization of Subscriber Acquisition Costs in 1995 = $60,924 million Tax Deduction if Subscriber Acquisition Costs were expensed = $111,761 million * 0.34 = $ 37,999 million Tax Deduction if Subscriber Acquisition Costs were capitalized = $60,924 million * 0.34 = $ 20,714 million By expensing instead of capitalizing, AOL is able to derive a much larger tax benefit ($37,999 million instead of $20,714 million). The differential tax benefit can be written as: Differential Tax Benefit = $37,999 - $20,714 = $17,285 million ?? ?? ?? ?? Case1: America Online Inc. Strategy Analysis ...read more.

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