Answer 10 Question and tables given for some question are in the last pictures.

Mr. Entrepreneur's Story Part 1 a When Mr. Entrepreneur was in his twenties, he decided to start a business. Since he was from the province of British Columbia, where there are a lot of timber available, he decided to get into furniture making business. After some research, he found out that furniture business has the following characteristics: 1. This business is very cyclical. When general economy is in good shape, the demand for furniture is strong and vice versa. 2. This business is very competitive. There are many furniture makers in the market. 3. This business is subject to various governmental regulations, including International trade, safety, and environmental regulations. They have an impact, sometimes beneficial, sometimes detrimental, on the industry. Eventually Mr. Entrepreneur decided to go ahead and try his luck in the furniture making business specializing in baby furniture. The ABC Corp. was born and started operation on Jan 1st 2018. The initial company ownership structure was Mr. Entrepreneur invested all his inheritance in the company. He was the only shareholder of the company. The total number of common stock shares issued and outstanding were 100,000 shares. Part 2 I After two years of operation, Mr. Entrepreneur was contemplating to take the company public - meaning he is considering selling some of his shares to public so that he can raise some capital to improve and expand his business into USA. For this purpose, he hired a brokerage firm (Mr. Broker) to conduct an initial feasibility study, trying to assess how feasible for him to carry out an IPO - Initial public offering plan. Mr. Broker's job involves the assessment of company's operation in the following areas: 1. The profitability of the company as compared with industry average 2. The efficiency of the company operation 3. The liquidity of the company 4. Debt utilization It is Mr. Broker's job to come up an objective assessment of overall company performance as compared with the industry averages. In addition, Mr. Broker is expected to provide guidance for pricing the share price to sell to the public. The rough estimation of the shares can be based on industry average P/E ratio and expected earnings of the company. To this end, the potential Earnings Per Share (EPS) growth rate is going to be similar to the average industry growth rate of 8%. Part 3 Page 3 of 11 Mid-term Assessment - Mr. Entrepreneur's story - a case study Mr. Entrepreneur just hired a financial consultant (Ms. Consultant) trying to take advantage of some of the financial strategies in order to improve his company performance. Ms. Consultant explained to Mr. Entrepreneur the magic effects of what is called Operating and Financial leverage. He told Mr. Entrepreneur that in order to increase the operating leverage Mr. Entrepreneur should invest in more capital assets - purchasing more equipment and automating more of factory operations. As for taking advantage of what is called financial leverage, Ms. Consultant suggests Mr. Entrepreneur to mix up his financing sources - She suggested Mr. Entrepreneur should use more debt in financing than in the past. Ms. Consultant calculated company's DOL and DFL. The numbers were: DOL - Contribution Margin Operating Income 324,020 = 3.6 90,050 DFL = Operating Income Earning before tax 90,050 = 0.98 90,980 Ms. Consultant commented on these numbers and told Mr. Entrepreneur that his company was a little bit on the conservative side with respect in using operating and financial leverage, as compared with industry average. The industry average numbers for DOL and DFL are 5 and 2.5 respectively. She consequently made a number of suggestions to Mr. Entrepreneur: 1. Mr. Entrepreneur should make more investment in the company capital assets, purchasing more modern equipment to improve its productivity, 2. Mr. Entrepreneur should use more debt to finance his capital assets acquisition in order to take better advantage of financial leverage it offers. Page 4 of 11 Mid-term Assessment - Mr. Entrepreneur's story - a case study Mr. Entrepreneur felt good about what Ms. Consultant suggested and planned to implement some new asset acquisition and financing plans. Part 4 Thanks to recent buoyant economic growth, the demand for Mr. Entrepreneur's baby furniture has been strong and business has been very good with a big backlog of orders. However, Mr. Entrepreneur noticed that very often he did not have enough cash to cover all the bills due. He was a little puzzled by the situation. Mr. Entrepreneur asked his accountant to explain to him what is going on. Style Part 4 Thanks to recent buoyant economic growth, the demand for Mr. Entrepreneur's baby furniture has been strong and business has been very good with a big backlog of orders. However, Mr. Entrepreneur noticed that very often he did not have enough cash to cover all the bills due. He was a little puzzled by the situation. Mr. Entrepreneur asked his accountant to explain to him what is going on. Mr. Accountant explained. Because there is a cash gap between inventory holding period, account receivable collection period and account payable period, the company without sufficient financing will face short-term cash crunch. To solve this problem, the company needs to secure adequate external financing. 1 After hearing Mr. Accountant's explanation, Mr. Entrepreneur now feels much relaxed. To him, if lack of financing is indeed the problem, then he can easily solve this problem by talking to his bank to arrange for some loans and credit lines for the company - all short-term financing vehicles. Mr. Accountant knows there should be more factors to be considered in term of financing. But since he has limited financing training, he cannot elaborate as to exactly what needs to be considered. This is very frustrating to him. Questions: (Total marks 65) 1. Considering the characteristics of the business Mr. Entrepreneur wanted to enter in your opinion, what organization form his business should be taken? (Sole proprietorship? Partnership? Or corporation?) Provide at least three reasons to back up your choice. (4 marks - 1 mark for the choice and 1 mark for each reason) 2. Referring to the statement of Cash Flow (table 3), from a cash flow point of view, what area did company generate the majority of its cash? (3 marks) What does this information suggest about company operation? (2 marks) 3. What are the major limitations of Income Statement and Statement of Financial Position? What can you suggest to minimize these limitations? (5 Marks) 4. In your opinion, how Mr. Entrepreneur has been doing with his business in terms of profitability, operational efficiency, liquidity and debt utilization? Use the template below and data from Table 1 and Table 2 to answer your questions. (16 marks - 2 marks for each ratio, show calculation) ABC Corporation Industry Average Category Profitability Better / worse Profit margin 10% Return on Assets 20% 15% 5.5 Return on Equity Operation Efficiency Inventory turn-over Total assets turn-over Liquidity Current Ratio 1.15 2.5 Quick ratio 1.2 Debt Utilization Debt to equity 0.40 Show Calculation: Example: Profit margin Net Income Sales 86,000 480,000 0.1791 = 17.92% 5. Finance managers often use what is called Trend Analysis to analyze company performance over time. What is the Trend Analysis? (3 marks) How are we going to perform a Trend Analysis for Mr. Entrepreneur's company? (3 marks) 6. What is the DuPont Model? (3 marks) Using DuPont model, comment on how to improve company's return on equity (ROE) (3 marks). 7. Ms. Consultant has suggested Mr. Entrepreneur to increase capital investment in equipment and tools in order to take advantage of operating leverage effect. Also, she has suggested increasing amount of debt in total financing in order to utilize financial leverage effect. Do you agree or disagree with her suggestions? (2 marks), and why? (3 marks)? What are the factors you need to consider in order to implement her suggestion properly? (3 marks) 8. Ms. Consultant calculate DOL and DFL numbers for Mr. Entrepreneur. What do DOL = 3.6 and DFL = 0.989 mean? (4 marks-2 marks for each answer). 9. Why, in your opinion, did Mr. Entrepreneur face period of short-term cash crunch in his 9. Why, in your opinion, did Mr. Entrepreneur face period of short-term cash crunch in his operation despite the fact his business was doing really well? (3 marks) Theoretically speaking, what financing choices did Mr. Entrepreneur have? (3 marks) 10. Mr. Entrepreneur had trouble to understand what permanent current assets are. Explain to Mr. Entrepreneur what permanent current assets are and make sure use am example in your explanation. (5 Marks) Table 1-Statement of Financial Position ABC Corporation Statement of Financial Position As at Dec 31, 2019 2018 ASSETS Current assets Cash Account receivable Inventories Total current assets Equipment Accumulated depreciation TOTAL ASSETS $ 19,050 $ 11,250 45,200 57,700 76,500 49,000 140,750 117,950 127,000 62,000 (25,200) (35,000) $ 242,550 $ 144,950 LIABILITIES & SHAREHOLDERS' EQUITIES Current liabilities Account payable $ 38,600 $ 36,200 Income tax payable 1,200 3,800 Dividend payable 3,200 5,200 Total current liabilities 43,000 45,200 Loan payable 43,000 36,000 Common shares 50,000 40,000 Retained earnings 106,550 23,750 TOTAL LIABILITIES & SHAREHOLDERS' EQUITIES $ 242,550 $ 242,550 Table 2 - Statement of Income Table 2-2 Alternative Statement of Income ABC Corporation Statement of Income For the year ended Dec 31, 2019 ABC Corporation Statement of Income For the year ended Dec 31, 2019 $ 480,000 305,000 175,000 Sales revenue Variable costs Contribution margin Fixed costs $ 480,000 155,980 324,020 233,970 3,900 13,250 7,600 10,2000 90,050 90,050 Sales revenue Cost of goods sold Gross profit Expense Wages expense Rent expense Utilities expense Depreciation expense Income from Operation Other revenue and expense Gain on sale of equipment Interest expense Income before income tax Income tax expense Net income Total common shares EPS 3,900 3,900 (2,970) 90,980 Income from Operation Other revenue and expense Gain on sale of equipment Interest expense Income before income tax Income tax expense Net income Total common shares EPS (2,970) 90,980 4,980 $ 86,000 100,000 $0.86 4,980 $ 86,000 100,000 $0.86 Table -3 Statement of Cash Flow ABC Corporation Statement of Cash Flow For the year ended Dec 31, 2019 Cash flow from operating activities: Net Income Add: depreciation expense Less: gain on sale of equipment Add: decrease in account receivable Less: increase in inventory Add: increase in account payable Decrease in income tax payable Net cash provided(used) by operation $ 86,000 10,200 (3,900) 12,500 (27,500) 2,400 (2,600) $ 77,100 Cash flows from investing activities: Add: proceeds from the sale of equipment Less: Purchase of equipment Net cash provided(used) in investing activities 8,900 (90,000) $ (81,000) Cash flows from financing activities: Less: payment of dividends Add: Proceeds of borrowing - loan payable Add: Proceeds from issuing common stocks Net cash provided (used) by financing activities Total net change in cash (5,200) 7,000 10,000 $ 11,800 $ 7,800 Ending cash Opening cash Net change in Cash $ 19,050 11,250 $ 7,800 Mr. Entrepreneur's Story Part 1 a When Mr. Entrepreneur was in his twenties, he decided to start a business. Since he was from the province of British Columbia, where there are a lot of timber available, he decided to get into furniture making business. After some research, he found out that furniture business has the following characteristics: 1. This business is very cyclical. When general economy is in good shape, the demand for furniture is strong and vice versa. 2. This business is very competitive. There are many furniture makers in the market. 3. This business is subject to various governmental regulations, including International trade, safety, and environmental regulations. They have an impact, sometimes beneficial, sometimes detrimental, on the industry. Eventually Mr. Entrepreneur decided to go ahead and try his luck in the furniture making business specializing in baby furniture. The ABC Corp. was born and started operation on Jan 1st 2018. The initial company ownership structure was Mr. Entrepreneur invested all his inheritance in the company. He was the only shareholder of the company. The total number of common stock shares issued and outstanding were 100,000 shares. Part 2 I After two years of operation, Mr. Entrepreneur was contemplating to take the company public - meaning he is considering selling some of his shares to public so that he can raise some capital to improve and expand his business into USA. For this purpose, he hired a brokerage firm (Mr. Broker) to conduct an initial feasibility study, trying to assess how feasible for him to carry out an IPO - Initial public offering plan. Mr. Broker's job involves the assessment of company's operation in the following areas: 1. The profitability of the company as compared with industry average 2. The efficiency of the company operation 3. The liquidity of the company 4. Debt utilization It is Mr. Broker's job to come up an objective assessment of overall company performance as compared with the industry averages. In addition, Mr. Broker is expected to provide guidance for pricing the share price to sell to the public. The rough estimation of the shares can be based on industry average P/E ratio and expected earnings of the company. To this end, the potential Earnings Per Share (EPS) growth rate is going to be similar to the average industry growth rate of 8%. Part 3 Page 3 of 11 Mid-term Assessment - Mr. Entrepreneur's story - a case study Mr. Entrepreneur just hired a financial consultant (Ms. Consultant) trying to take advantage of some of the financial strategies in order to improve his company performance. Ms. Consultant explained to Mr. Entrepreneur the magic effects of what is called Operating and Financial leverage. He told Mr. Entrepreneur that in order to increase the operating leverage Mr. Entrepreneur should invest in more capital assets - purchasing more equipment and automating more of factory operations. As for taking advantage of what is called financial leverage, Ms. Consultant suggests Mr. Entrepreneur to mix up his financing sources - She suggested Mr. Entrepreneur should use more debt in financing than in the past. Ms. Consultant calculated company's DOL and DFL. The numbers were: DOL - Contribution Margin Operating Income 324,020 = 3.6 90,050 DFL = Operating Income Earning before tax 90,050 = 0.98 90,980 Ms. Consultant commented on these numbers and told Mr. Entrepreneur that his company was a little bit on the conservative side with respect in using operating and financial leverage, as compared with industry average. The industry average numbers for DOL and DFL are 5 and 2.5 respectively. She consequently made a number of suggestions to Mr. Entrepreneur: 1. Mr. Entrepreneur should make more investment in the company capital assets, purchasing more modern equipment to improve its productivity, 2. Mr. Entrepreneur should use more debt to finance his capital assets acquisition in order to take better advantage of financial leverage it offers. Page 4 of 11 Mid-term Assessment - Mr. Entrepreneur's story - a case study Mr. Entrepreneur felt good about what Ms. Consultant suggested and planned to implement some new asset acquisition and financing plans. Part 4 Thanks to recent buoyant economic growth, the demand for Mr. Entrepreneur's baby furniture has been strong and business has been very good with a big backlog of orders. However, Mr. Entrepreneur noticed that very often he did not have enough cash to cover all the bills due. He was a little puzzled by the situation. Mr. Entrepreneur asked his accountant to explain to him what is going on. Style Part 4 Thanks to recent buoyant economic growth, the demand for Mr. Entrepreneur's baby furniture has been strong and business has been very good with a big backlog of orders. However, Mr. Entrepreneur noticed that very often he did not have enough cash to cover all the bills due. He was a little puzzled by the situation. Mr. Entrepreneur asked his accountant to explain to him what is going on. Mr. Accountant explained. Because there is a cash gap between inventory holding period, account receivable collection period and account payable period, the company without sufficient financing will face short-term cash crunch. To solve this problem, the company needs to secure adequate external financing. 1 After hearing Mr. Accountant's explanation, Mr. Entrepreneur now feels much relaxed. To him, if lack of financing is indeed the problem, then he can easily solve this problem by talking to his bank to arrange for some loans and credit lines for the company - all short-term financing vehicles. Mr. Accountant knows there should be more factors to be considered in term of financing. But since he has limited financing training, he cannot elaborate as to exactly what needs to be considered. This is very frustrating to him. Questions: (Total marks 65) 1. Considering the characteristics of the business Mr. Entrepreneur wanted to enter in your opinion, what organization form his business should be taken? (Sole proprietorship? Partnership? Or corporation?) Provide at least three reasons to back up your choice. (4 marks - 1 mark for the choice and 1 mark for each reason) 2. Referring to the statement of Cash Flow (table 3), from a cash flow point of view, what area did company generate the majority of its cash? (3 marks) What does this information suggest about company operation? (2 marks) 3. What are the major limitations of Income Statement and Statement of Financial Position? What can you suggest to minimize these limitations? (5 Marks) 4. In your opinion, how Mr. Entrepreneur has been doing with his business in terms of profitability, operational efficiency, liquidity and debt utilization? Use the template below and data from Table 1 and Table 2 to answer your questions. (16 marks - 2 marks for each ratio, show calculation) ABC Corporation Industry Average Category Profitability Better / worse Profit margin 10% Return on Assets 20% 15% 5.5 Return on Equity Operation Efficiency Inventory turn-over Total assets turn-over Liquidity Current Ratio 1.15 2.5 Quick ratio 1.2 Debt Utilization Debt to equity 0.40 Show Calculation: Example: Profit margin Net Income Sales 86,000 480,000 0.1791 = 17.92% 5. Finance managers often use what is called Trend Analysis to analyze company performance over time. What is the Trend Analysis? (3 marks) How are we going to perform a Trend Analysis for Mr. Entrepreneur's company? (3 marks) 6. What is the DuPont Model? (3 marks) Using DuPont model, comment on how to improve company's return on equity (ROE) (3 marks). 7. Ms. Consultant has suggested Mr. Entrepreneur to increase capital investment in equipment and tools in order to take advantage of operating leverage effect. Also, she has suggested increasing amount of debt in total financing in order to utilize financial leverage effect. Do you agree or disagree with her suggestions? (2 marks), and why? (3 marks)? What are the factors you need to consider in order to implement her suggestion properly? (3 marks) 8. Ms. Consultant calculate DOL and DFL numbers for Mr. Entrepreneur. What do DOL = 3.6 and DFL = 0.989 mean? (4 marks-2 marks for each answer). 9. Why, in your opinion, did Mr. Entrepreneur face period of short-term cash crunch in his 9. Why, in your opinion, did Mr. Entrepreneur face period of short-term cash crunch in his operation despite the fact his business was doing really well? (3 marks) Theoretically speaking, what financing choices did Mr. Entrepreneur have? (3 marks) 10. Mr. Entrepreneur had trouble to understand what permanent current assets are. Explain to Mr. Entrepreneur what permanent current assets are and make sure use am example in your explanation. (5 Marks) Table 1-Statement of Financial Position ABC Corporation Statement of Financial Position As at Dec 31, 2019 2018 ASSETS Current assets Cash Account receivable Inventories Total current assets Equipment Accumulated depreciation TOTAL ASSETS $ 19,050 $ 11,250 45,200 57,700 76,500 49,000 140,750 117,950 127,000 62,000 (25,200) (35,000) $ 242,550 $ 144,950 LIABILITIES & SHAREHOLDERS' EQUITIES Current liabilities Account payable $ 38,600 $ 36,200 Income tax payable 1,200 3,800 Dividend payable 3,200 5,200 Total current liabilities 43,000 45,200 Loan payable 43,000 36,000 Common shares 50,000 40,000 Retained earnings 106,550 23,750 TOTAL LIABILITIES & SHAREHOLDERS' EQUITIES $ 242,550 $ 242,550 Table 2 - Statement of Income Table 2-2 Alternative Statement of Income ABC Corporation Statement of Income For the year ended Dec 31, 2019 ABC Corporation Statement of Income For the year ended Dec 31, 2019 $ 480,000 305,000 175,000 Sales revenue Variable costs Contribution margin Fixed costs $ 480,000 155,980 324,020 233,970 3,900 13,250 7,600 10,2000 90,050 90,050 Sales revenue Cost of goods sold Gross profit Expense Wages expense Rent expense Utilities expense Depreciation expense Income from Operation Other revenue and expense Gain on sale of equipment Interest expense Income before income tax Income tax expense Net income Total common shares EPS 3,900 3,900 (2,970) 90,980 Income from Operation Other revenue and expense Gain on sale of equipment Interest expense Income before income tax Income tax expense Net income Total common shares EPS (2,970) 90,980 4,980 $ 86,000 100,000 $0.86 4,980 $ 86,000 100,000 $0.86 Table -3 Statement of Cash Flow ABC Corporation Statement of Cash Flow For the year ended Dec 31, 2019 Cash flow from operating activities: Net Income Add: depreciation expense Less: gain on sale of equipment Add: decrease in account receivable Less: increase in inventory Add: increase in account payable Decrease in income tax payable Net cash provided(used) by operation $ 86,000 10,200 (3,900) 12,500 (27,500) 2,400 (2,600) $ 77,100 Cash flows from investing activities: Add: proceeds from the sale of equipment Less: Purchase of equipment Net cash provided(used) in investing activities 8,900 (90,000) $ (81,000) Cash flows from financing activities: Less: payment of dividends Add: Proceeds of borrowing - loan payable Add: Proceeds from issuing common stocks Net cash provided (used) by financing activities Total net change in cash (5,200) 7,000 10,000 $ 11,800 $ 7,800 Ending cash Opening cash Net change in Cash $ 19,050 11,250 $ 7,800