25742 Financial Management Case Study

Report submission via Canvas by 23:59 on Wednesday 17 May 2023. Franklin Smash Repairs

Franklin Smash Repairs Pty Ltd (FSR) is a smash repair business located in the eastern suburbs of Sydney. The business was started by William Franklin in the late 1950s but is now run by David and Jack Franklin, the two sons of founders of the business. David and Jack each own 30% of the issued ordinary shares in the company but several other family members also own shares and the company is expected to perform well and pay annual dividends. The companys Board of Directors consists of David, who is Managing Director, Jack, their sister Amy and their cousin Grace who is the company secretary. There is one independent director and he is Richard Ellis a family friend and the family tax accountant. The company chairman is their Uncle, John Franklin who was the other founder of the company. Grace works in the business as the Accountant/Office Manager and has recently completed an MBA at UTS.

The smash repair business has been through some turbulent times in recent years mainly due to the increasing dominance and control exerted by the major insurance companies. FSR has survived and managed to remain profitable through the reorganisation of the industry and is a registered repairer for the major insurance companies and this ensures a steady stream of insurance work. On top of this Jack has built up a good reputation with two historic car clubs that has resulted in restoration work on vintage cars that has proved profitable and interesting work.

The company operates from premises that it has owned since the business was incorporated. At the time of incorporation it was decided to purchase two adjoining blocks of land and construct the workshop, spray booth and office on one block and keep the other as an investment or for future expansion. During the years the buildings have been renovated and updated several times with the last occasion being only sixteen months ago when a new spray booth was constructed. The workshop etc is still contained on one block. The other block is still vacant, not very securely fenced and has to be maintained by one of the local lawn mowing contractors to keep the grass and shrubs tidy. This maintenance currently costs $17,000 p.a. and is expected to increase by 3% p.a. for the next ten years. This expense will be eliminated if the site is developed. For some time now Amy and Grace have been advocating selling the land as it would release a significant amount of money which could be paid out

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to shareholders as a special dividend. However, John has always had a dream that the land would be used to expand the business and is not keen to sell. The company is working at full capacity five days a week and Saturday overtime is not unusual. Some historical car work had to be declined recently. The major bottleneck is the spray booth where cars have to remain for a minimum drying period. The company has two spray booths but one can only be used for parts not full bodies. The company also had a problem with the parking of vehicles during the day and could only use the spare ground for parking during dry weather. In wet weather shuffling cars was not only frustrating but an inefficient use of staff time.

Some months ago, John had asked David and Jack to investigate the feasibility of expanding the business and Jack has just completed an overseas trip (a combination of work and holiday with his wife and family) during which he completed some research into the latest techniques used in the smash repair business in Europe. He had also studied the latest spray booth technology and had been very impressed by a new German spray booth. The trip had been very expensive and it had cost $39,500 for airfares, accommodation and meals. As most of the trip was business the company has paid for this expense. On returning from the trip Jack met with John, David and Grace to outline an idea that he had been considering for some time.

Jack stated at the meeting that he believed that if the company added a new spray booth and workshop at the back of the vacant block he would be able to significantly increase business particularly in the restoration of vintage and historical cars. Car clubs were growing and keeping the cars in pristine condition was important to the enthusiasts in these clubs. FSR had built up a solid reputation for high quality work in this area and this work provided far bigger margins than insurance work. He firmly believed that FSR would also be able to take on more insurance work with the increased spraying capacity. Jack tabled a projected revenue forecast for both the historical car business and increased insurance work. The forecast revenue is detailed in Appendix 1. He also outlined some preliminary estimates on the costs involved. The building to house the spray booth and workshop would cost about $256,000 to erect. The building would be constructed on the back half of the block and the front half of the block would be converted to an all-weather car park for cars awaiting repair and customer and staff parking which would improve efficiency. The costs of the car park construction are estimated to be $74,000. The biggest cost would be the spray booth and the associated equipment. He had a firm quote from the German company and the total cost including all shipping, installation and testing would be $348,000.

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The number of employees would be increased. At the start of the new business a new supervisor would be required for the new area. One of the current employees will be promoted. The increase in wages cost of his promotion including all on-costs will be $16,000 p.a. His current position in the current building would have to be replaced at a total cost per annum of $66,000. Details of the other agreed increases in wages are shown in Appendix 1. It was also agreed that an allowance would be made in the analysis for all wages to increase by 3% p.a.

There was no additional information available on building costs and it had been agreed that a 5% contingency be included on both the building and car park. Increased building maintenance costs are shown in Appendix 1.

The parts and material costs for the new business have been estimated as a percentage of revenue. The percentage for insurance work is 45% and for the historical car work is 20%. The costs of all general consumables i.e. paint, nuts, bolts cleaning rags etc. are shown in Appendix 1.

David has told Jack that there are old tools and equipment held in the current warehouse that could be used in the new building. Although several years old they are fully depreciated and the new project could have them at no cost. The tools had recently been appraised for insurance purposes and had a market value of $15,000.

Grace has analysed the cash flow and the company would have to borrow $600,000 to finance the project. The bank has given preliminary approval but want to see a final business plan. The interest rate would be 8.25% p.a. and the loan will be repayable over 7 years with a monthly repayment figure of $9,900.

The company pays tax at a corporate tax rate of 30%.

Richard Ellis has stated that a return of 15% on an investment of this type is appropriate.

Land is not depreciable and no capital gains tax will apply. In ten years it is estimated that the

land could be sold for about $355,000. The tax office has determined that the buildings can be depreciated at 8% straight line based on cost and the spray booth can also be depreciated at 20% straight line.

David has asked that the project be analysed over ten years as it is very uncertain if the business will continue after that date.

In ten years time, the old tools will have no value and the spray booth would only have a scrap value of $18,000. The buildings will not add to the land value at the time of sale and can be considered to have no value in ten years time.

There would be an increase in inventory of common spare parts at the start of the project with a value of $23,000.

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Your task:

As a friend of Grace, you have been asked to assist her preparing a capital budgeting analysis report for David and the family that includes an executive summary. The report must contain:

1. An executive summary containing your recommendation to accept or reject the project and your financial analysis and reasons for the recommendation and any other factors Grace should consider other than your spreadsheet answer. The report must address Graces concerns regarding the insurance business. The report should be a maximum of two A4 pages (Single space 12 font). (5 marks)

2. A readable spreadsheet clearly showing the NPV of the project and all relevant cash flows, the appropriate discount rate and calculations that are used to support your decision. Financial analysis should address Graces concerns regarding the insurance business. (15 marks)

APPENDIX 1

Historic Cars Insurance

Franklin Smash Repairs Revenue Forecast $

Year 1

570,000 78,000

Year 2

645,000 150,000

Year 3

720,000 200,000

Year 4

750,000 250,000

Year 5

772,500 257,500

From year 4 onwards total revenue will only increase in line with the expected general rate of inflation which is expected to be 3%.

Year 1 Number of New 2

Employees Wages Cost 120,000

Year 2

3 185,400

Year 3

4 254,616

Year 4

4 262,254

Year 5

4 270,122

Wages Forecast $

Note: The above figures exclude the increased cost of the supervisor and the new employee in the old building. Wages costs are expected to increase by 3% p.a. from year 4 onwards

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Costs Forecast $

Materials Historic Cars Materials Insurance Building Maintenance General Consumables

Year 1 114,000 35,100 6,000 64,800

Year 2 129,000 67,500 7,500 79,500

Year 3 144,000 90,000 15,000 92,000

Year 4 150,000 112,500 20,000 100,000

Year 5 154,500 115,875 20,600 103,000

Note: All the costs shown above are expected to increase by 3% from year 4 onwards

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