Hope Enterprises Ltd. is a Canadian-controlled private corporation that operates a jewellery manufacturing business in southwestern Ontario. The company was profitable for a number of years until a new competitive environment put the company in financial difficulty. For the past eight years, Hope Enterprises has suffered serious losses. Currently, it has unused non-capital losses of $650,000. Jean Talouse, the president and sole shareholder, has called a meeting of his senior staff to review the company’s operations for the year and to plan a survival strategy. The meeting begins with the accountant presenting the current year’s financial statements and a projection of operating results for the next three years. Part of this information is outlined in the tables on the next page.
The accountant reports the following additional information:
1. The company realized a gross profit of 20% on sales of $4,000,000, which is considerably lower than normal. However, all of the bad inventory has been cleaned out, and the current inventory can be sold to realize a 25% gross profit.
2. The accounts receivable represents a true evaluation of what can be collected. A reasonable reserve has been taken into account, and the credit policy has been adjusted to reduce the losses on future sales.
3. Both the bank loan and the loan from the shareholders are payable on demand and require interest payments of 9%.The bank is not uncomfortable with the current level of debt and has adequate security in the receivables and inventory.
4. To ensure that only a minor loss will result this year, expenses have been cut to the bone. The projections are that over the next three years, if conditions remain basically the same, the company will suffer minor losses or perhaps break even.
5. The $650,000 loss carry-forward for tax purposes is a cause for concern. Some of this loss will expire in two years, and so there is a possibility that the company will not generate profits in time to use the loss.
The president is pleased that the company has got the losses under control. He instructs the accountant to determine whether any action can be taken to minimize the risk of the losses expiring. Although he did not say so at the meeting, the president has decided to investigate the possibility of selling the company, as he feels that things may get worse in spite of the accountant’s projections.
Required:
1. What steps can be taken to ensure that the loss carry-forward of $650,000 will not expire before profits are generated? Be specific, and indicate the amount of losses that will be preserved by your actions.
2. What can the president do to maximize the value of the shares in the event that he actively solicits a buyer for the company?