1.Project a pro-forma income statement, balance sheet, and statement of cash inflows and outflows for fiscal 1997 and 1998 for ONLY the new location, using the information presented in the case.Present the financials in Cayman Island dollars; do not translate into US dollars. The fiscal year starts June 1 and ends May 31.

a.Clearly show how you projected your revenues. Hint: use the regression equation shown in exhibit 3 to project revenues, but not for profits, and adjust for the circumstances of the new shop.

b. State clearly any assumptions that you make to complete the financial statements.

AICPA Case Development Program Case No. 97-01: Should the Scuba Business Dive Into the Expansion 1

SHOULD THE SCUBA BUSINESS DIVE

INTO THE EXPANSION?

Michael H. Moms, Professor of Accountancy

University of Notre Dame, Notre Dame, Indiana

Andrew M. Crowe, Controller

Don Foster's Dive Cayman, Ltd., Cayman Islands

As controller and general manager of Don Foster's Dive Cayman, Ltd., Andy Crowe knew that something had to be done to improve the profit performance of the company. Although profits increased for several years after incorporating in July of 1991, sales revenue declined during the last two years, with the company reporting a loss for fiscal 1996. Andy knew that the current fleet of dive boats were being underutilized, so the timing was right to examine ways to expand sales revenue.

ENVIRONMENT

Don Foster's Dive is located in the Cayman Islands, a self-governing British crown colony, situated 480 miles south of Miami. To vacationers, the Cayman Islands mean calm clear waters and a carefree world of outdoor pleasures. To scuba divers and snorkelers, the Caymans are synonymous with the world's best diving. Not only are the quality and variety of the dive sites spectacular, but the Cayman Islands also possess a unique dive site called Stingray City. At this location, divers and snorkelers swim with 30 to 40 wild stingrays that feed from human hands.

To investors, the Cayman Islands are a reliable tax haven. There are no corporate, capital gains, payroll, property or withholding taxes on the islands. The absence of taxes on income together with political and racial stability, has attracted the attention of investors seeking a tax free base for their operations. Currently there are approximately 32,000 companies, 550 banks, 900 mutual funds and 400 insurance companies of various categories registered or licensed in the Cayman Islands. Those companies operate from an environment in which there are no excessive restrictions on their freedom to trade or their ability to transact business in any part of the world. In addition, disclosure of information by government officials, professional agents, attorneys and accountants and their staffs is forbidden by law under severe penalties.

BUSINESS

Don Foster's Dive specializes in providing vacationers with a wide variety of exciting watersports activities including the rental of snorkeling equipment, wave runners, sail boats, wind surfers, floating mats, and plastic kayaks. Parasailing and other local excursions are also offered through Don Foster's Dive, but its primary line of business is providing scuba diving trips and instruction.

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AICPA Case Development Program Case No. 97-01: Should the Scuba Business Dive Into the Expansion 2

Scuba is an acronym for Self-Contained Underwater Breathing Apparatus. The breathing apparatus consists of a tank containing pressurized air and a regulator that delivers the air to the diver on each inhalation. Other basic equipment includes a soft rubber face mask to improve visibility, swimming fins to enhance mobility, and a vest, called a buoyancy compensator device, to help regulate divers' depth while submerged and to keep divers afloat when they are on the surface of the water.

Don Foster's Dive maintains twenty employees to staff the dive shops and dive boats, provide various levels of instruction, and guide divers while underwater. It maintains six dive boats in various locations around the island in addition to the wide variety of watersports equipment. Don Foster's Dive provides two dives in the morning, starting about 9:00 a.m., one dive in the afternoon, and a final dive at night. Customers are either transported by Don Foster's Dive vans to the dive boat or picked up at the beach in front of their hotel. Divers can explore wrecks, walls (huge underwater cliffs), and reefs. Dive instruction, equipment, and information about the 200 different dive locations in the Caymans are provided by their experienced, professional instructors on the way to the dive site.

OVERVIEW OF THE PROBLEM

Increased competition in the dive industry in the Cayman Islands has caused revenues to stagnate and even decline in recent years (see Exhibit 1). With a huge investment in boats and diving equipment, (see fixed assets in Exhibit 2) Don Foster's Dive must find a way to utilize excess capacity. Since about 40 percent of its $2.4 million dollars of revenue arise out of a single dive and watersports rental shop located on the beach just outside a resort hotel, Andy thought about expanding to a second dive shop, located near the other end of the famous 7 Mile Beach. After considering several locations, he settled on the Holiday Inn because of its superior beach location and the fact that it attracts a younger more family oriented clientele, who are more likely to participate in watersports activities. He approached the Holiday Inn owners with a proposal to have Don Foster's Dive open a full service dive and watersports facility at the resort. The owners were interested in offering their guests a wide variety of watersports activities and dive services. They agreed to provide a small building on their premises and the exclusive license to provide diving and other watersports services at their hotel in return for the minority interest in a 60/40 split of any profits generated by the proposed dive shop. Don Foster's Dive would renovate the shop and provide vessels and staff for the new venture. Although the proposal sounded exciting for Don Foster's Dive, Andy wasn't sure of the viability of the venture given the additional investment it would require and its unknown impact on assets, debt, cash flow and income. Andy knew the first step was to determine the impact of the expansion on profits and to obtain proforma (projected) financial statements that he could carry to the bank to justify the necessary financing. Don Foster's Dive just completed its 1996 fiscal year on May 31, and could have the new facility open on a limited basis in a matter of days after signing the contract.

OPERATIONAL ISSUES

Although there is some uncertainty in the incremental business the new dive shop would generate, Andy has obtained data that can help with the projections. He contacted the local Department of Tourism and obtained statistical data for a dive shop on the beach outside the Radisson Resort, which is similar to the proposed site. Using those statistics, he estimated monthly sales and profit from operations (provided in Exhibit 3 along with a trend line) for the dive and watersports facility during the last three years. Given Andy's experience with the business, he feels confident that the trend established from the data at the Radisson dive shop would be representative of business at the new Holiday Inn location. Adjustments for the difference in size of the hotels (Radisson Resort has 330 rooms and the Holiday Inn has 230 rooms) would, of course, have to be made in order to get accurate annualized projections of sales revenue and profit from operations. In addition, Andy knows that it takes approximately one year for a new shop to reach its full sales potential. From recent experience in opening new dive shops for Don Foster's Dive and in talking to competitors along 7 Mile Beach, Andy believes that revenue and profit from operations at the proposed site for the first year will be 50 percent of subsequent figures and operating expenses (mostly variable) will be ten times as large as adminiistrative expenses on the new facility for the

AICPA Case Development Program Case No. 97-01: Should the Scuba Business Dive Into the Expansion 3

foreseeable future. All other previously existing facilities at Don Foster's Dive are expected to yield about the same revenue, expenses and income as in 1996.

The additional investment required by Don Foster's Dive to open the new shop includes $31,000 for building improvements and signs; $ 17,500 for waverunners, aqua trikes, sailboats, kayaks, and floating chair mats; $10,000 for additional scuba equipment; $20,000 for increased retail inventory and $5,000 for additional computer equipment. All of the investments are anticipated to be financed by a long-term bank loan which together with existing long-term bank loans will be repaid in equal installments of $4,008 per month (exclusive of interest). The existing note payable is also reduced by monthly payments of $9,070 (exclusive of interest). The interest cost on both debt instruments is part of the administrative expense component on the income statement. If the purchases are made, the total depreciation expense (included with operating expenses) using a straight line method is expected to increase by $15,000 to about $65,000 per year on all fixed assets (all figures are stated in CI dollars).

EXHIBIT 2 DON FOSTER'S DIVE CAYMAN LTD. BALANCE SHEETS (UNAUDITED) MAY 31 1996 1995 1994 Current Assets: Cash 1,038 1,004 1,701 Accounts Receivable 54,744 67,547 49,502 Inventory 38,103 43,860 46,341 Total Current Assets 93,885 112,411 97,544 Non-Current Assets: Investments $ 3,000 $ 167,000 $ 167,000 Fixed Assets $1,220,097 $1,270,631 $1,341,818 Goodwill $ 384,950 $ 384,950 $ 384,950 Total Non-Current Assets $1,608,047 $1,822,581 $1,893,768 Total Assets $1,701,932 $1,934,992 $1,991,312 Current Liabilities: Short-term Bank Loan 93,608 $ 140,293 $ 122,941 Customer Deposits 46,913 $ 69,349 36,984 Accounts Payable 158,437 113,293 141,415 Total Current Liabilities $ 298,958 $ 322,935 301,340 Long-term Liabilities: Long-term Bank Loan 156,958 $ 189,910 $ 264,953 Note Payable $ 870,741 $ 979,591 $1,078,123 Total Long-term Liabilities $1,027,699 $1,169,501 $1,343,076 Shareholders' Equity: Capital Stock 82 82 82 Paid-In Capital 223,094 223,094 163,377 Retained Earnings $ 152,099 $ 219,380 $ 183,437 Total Equity $ 375,275 $ 442,556 $ 346,896 Total Liabilities and Equity $1,701,932 $1,934,992 $1,991,312\fEXHIBIT 3 RADISSON DIVE SHOP MONTHLY SALES REVENUE (TOP) AND PROFIT FROM OPERATIONS (BOTTOM) 120,000 100,000 y = -556.57x + 98416 80,000 Cayman Dollars 60,000 40,000 y = -412.64x + 34096 20,000 Jun-93 Sep-93 Dec-93 Mar-94 Jun-94 Sep-94 Dec-94 Mar-95 Jun-95 Sep-95 Dec-95 Mar-96