As Katherine reflected on the past 15 or so years, she couldn't believe how far she'd come. What started out as a small dream to be her own boss ended up being a major journey that ended up with Katherine being the CEO of a multimillion dollar high-end chocolate company located in southern Ontario. But now that she had come this far, she wanted to try and be truly pan-Canadian, with the obvious provision that it made sound business sense. Given the financial performance and return provided to its investors, Katherine and her company had been the darlings of the investment community; but that was just part of the story. What made the financial performance so incredible was that it was done while also emphasizing social responsibility in the downstream value chain, specifically cocoa farmers. As a result of the efforts of Katherine and her mentor Fred Currie (see Parts 1 through 3), who had come out of retirement to help Katherine promote her social agenda, the company had made an incredible impact on the lives of the smaller chocolate producers in some of the poorest countries in the world. They had introduced better crop management practices, helped improve logistics in terms of getting the cocoa beans to market, and so on. These initiatives resulted in the smaller farmers being able to produce and sell more and better chocolate, and substantially increase their standard of living. It was as a result of this publicity that Katherine received a phone call from Bink and Tashie's Chocolates in Winnipeg, Manitoba. (Their real names are Bianca and Natasha, but for the company name, they used their nicknames from when they were growing up.) They were getting set to retire and wanted to sell Katherine their business. They mass produced high-end chocolate for a variety of corporate clients in the Saskatchewan, Manitoba, and northern Ontario regions. Their latest (abbreviated) financial statements are shown in Exhibit #1. While the business wasn't tremendously profitable, the two owners were paying themselves a combined salary of $200,000 plus they received an additional 10% in benefits. When Bianca and Natasha approached Katherine, she told them that she really only wanted the production facility and its employees, but not the employees associated with overhead as her company's existing sales and support people would be able to absorb the duties of the people Bink and Tashie's presently employed. Bianca and Natasha replied that they thought as much and that's why they were approaching Katherine. The owners explained that their six employees (four salespeople and two office staff) had been with them from virtually the beginning and, given Katherine's Chocolate Kompany's reputation of "doing the right thing," Bianca and Natasha were hopeful that Katherine would see fit to pay the employees one year of salary as severance pay plus 50% of the bonus the salespeople typically received, of which last year's amount was a good indication. Katherine thought that the price the owners were asking ($5.5 million) was quite exorbitant, even after allowing for the value of the land, building, and equipment. So, while Katherine did understand the owners wanting to look after their workers, she was somewhat peeved that they thought it should come out of her coffers instead of theirs. Nonetheless, she agreed to consider this cost in her decision. The timing of Bianca and Natasha's offer to sell couldn't have come at a better time. Katherine's Chocolate Kompany had no presence outside Ontario and she had been eyeing setting up an operation similar to Bink and Tashie's in the greater Winnipeg area for some time, given its size and central geographic position relative to Saskatchewan and northern Ontario. From this base, she thought that eventual expansion into the retail market in this area would make perfect sense, as well as moving further west. In fact, she had located what was an ideal location and was planning on building a production facility similar to the one Bink and Tashie's was offering for sale. The benefits of buying the business from Bianca and Natasha would include a solid customer base that was unlikely to switch companies provided product and service quality didn't slip after the purchase. Building a facility from scratch would mean a significant uphill battle to acquire market share. Granted, with all the media attention given to KCK's award-winning chocolates and corporate social responsibility initiatives, Katherine and her company's reputation preceded her such that she had no doubt she would eventually push Bianca and Natasha, or their purchaser, out of business, but that wasn't her style and certainly ran counter to the company's ethical standards. Regardless of the ethical considerations that may influence the final decision, Katherine still had to "do the math" with respect to the financial viability of both options. Exhibit #2 provides details with respect to the cost and cash flows of the two options.

Multiple-Choice Questions

1. What are the present values of the net tax shields for each option? a) $81,266 and $131,194 b) $339,330 and $394,356 c) $338,056 and $387,984 d) $336,579 and 380,599

2. What is the IRR for each option? Use the nearest tenth of a percent. a) 11.5% and 12.1% b) 12.0% and 13.0% c) 10.8% and 10.8% d) 11.2% and 11.3%

3. Which option has the highest NPV, and by how much over the other option? a) Option #2 - $53,161 b) Option #1 - $289,527 c) Option #1 - $739,537 d) Option #2 - $769.023

4. At what purchase price for Bink and Tashie's would the IRR equal the required rate of return? Use the nearest $10,000. a) $6,470,000 b) $6,560,000 c) $6,300,000

d) $6,380,000

5. What would the required rate of return have to be for Katherine to be indifferent between the two options? Use the nearest tenth of a percent. a) 11.1% b) 10.6% c) 11.2%

d) 10.3%

EXHIBIT #1
Bink and Tashie's Chocolate
Abbreviated Income Statement
For 2017
('000s of Dollars)
Sales		2,265
Cost of Goods Sold	1,430
Gross Margin		835
Overhead Salaries
Sales Salaries	300
Sales Bonus	100
Office Salaries	100
Owners' Salaries	200
Benefits	70
Total Overhead		770
Operating Profit		65
Taxes (30%)		20
Net Profit		45

EXHIBIT #2

Option #1 - Purchase Bink and Tashie's

Initial Costs

The $5.5 million purchase price consisted of the following:

1) $2 million for the building, which was its fair market value and would be used for CCA purposes

2) $500,000 for the land

3) $300,000 for the machinery, which was its fair market value and would be used for CCA purposes

4) $2.7 million for goodwill

In addition, for the purposes of this analysis, Katherine decided to include the severance packages for the salaried employees as requested by the owners of Bink and Tashie's. In terms of timing, she anticipated letting these people go immediately as she would simply absorb the work these people performed into the existing support functions of Katherine's Chocolate Kompany.

Yearly Cash Flow

In the first year (2018), Katherine anticipated sales being flat relative to the previous year and a cost of sales of 63%.

In the second through fifth year, sales were anticipated to grow 4% and then level off in years six through ten.

Cost of goods sold was anticipated to be 62% the second year and 59% from years three through ten.

Katherine anticipated $20,000 per year in overhead costs related to travel expenses for salespeople, etc.

Salvage Values

The machinery was expected to have a salvage value of $10,000 at the end of the tenth year.

There are no plans to sell the building.

Option #2 - Build Factory

Initial Costs

1) Purchase price of building - $2 million

2) Purchase price of machinery - $500,000

3) Purchase price of land - $500,000

Yearly Cash Flow

In the first year (2018), Katherine anticipated sales being $0.5 million and a cost of sales of 70%.

In the second year, Katherine anticipated sales being $0.7 million and a cost of sales of 65%.

In the third year, Katherine anticipated sales being $1.0 million and a cost of sales of 63%.

In the fourth year, Katherine anticipated sales being $1.2 million and a cost of sales of 60%.

In the fifth year, Katherine anticipated sales being $1.5 million and a cost of sales of 57%.

In the sixth through tenth year, Katherine anticipated sales being $1.8 million and a cost of sales of 57%.

In the first year, Katherine anticipated $60,000 in overhead costs related to travel expenses for salespeople and senior managers to establish the business. These costs were expected to be $30,000 in the second year and $20,000 from years three through ten.

Salvage Values

The machinery was expected to have a salvage value of $50,000 at the end of the tenth year.

There are no plans to sell the building.

Additional Information

CCA rates - Building 4%, Machinery 20%

Tax Rate for Bink and Tashie's - 30%

Tax Rate for Katherine's Chocolate Kompany - 40%

Required Rate of Return - 8%

Time horizon - 10 years