BB Pty Ltd (BB) is a large family owned, building company that operates in South Australia (1) Its operations are primarily directed towards the built-to-a-budget housing market associated with large land subdivisions and developments. The directors of BB are of the view that they are now ar a point in the company's growth where it would be advantageous to have some in-house architectural skills rather than just building to the plans of other developers. Another local company. Angles Pty Ltd (Angles). provides such services (iii) You have been contracted by BB to perform a due diligence on Angles as a potential acquisition target for BB. Your investigations to date reveal the following information about Angles: (1) Angles is owned by Max and Deidre Jones who are also the only two directors of Angles. Both Max and Deidre receive $25,000 per year for directors fees. In addition, Max receives a salary of $125,000 per year for management services and Deidre receives a salary of $40,000, although she is seldom at Angles. (2) Angles primarily provides architectural design and consultation services: approximately 60% of these services are for rich private customers for the design of their homes: 30% relates to commercial properties: and 10% is contract work for another builder who is currently a rival of BB's. Eight highly skilled architects are employed by Angles at an average salary in 2014 of 595.000 per year Your discussions with the staff indicate that the architects are proud of the quality of their work and like the challenge and prestige that comes from designing homes for some of South Australia's richest and greatest inhabitants. (3) Administrative expenses of Angles also include salaries for two part-time administrative staff ($50,000 in total). (4) Property, plant, and equipment primarily consist of office furniture, and computing equipment while the intangible assets are made up of special design software and capitalised interest. (5) The intangibles are not amortised and depreciation rates for PPE are derived from those specified for income tax purposes. (6) Angles loans are with Which Bank which has secured its interests with a mortgage over the assets of the business and Max and Deidre's home. The current interest rate on Angles' debt is 8% p.a (7) No provisions are made for doubtful debts because Angles' customers are very rich and famous. Discussions with Max and Deidre reveal that one of their customers (a well known radio personality) is suing Angles for alleged failures in the design of his home. Angles is refuting the claim and the matter is to go before the courts. Consultations with lawyers suggest that it will be at least two years before the matter is resolved and they are confident that there is about a 60% chance that Angles will win and pay no damages, a 30% chance that Angles will have to pay out $300,000, and a 10% chance that $450,000 will have to be paid. Legal fees are expected to average $80,000 over the next two years. It is possible that the matter might be settled out of court but this cannot be adequately predicted at present. As the whole issue is uncertain, there is no recognition of any related cost in the financial statements. (9) An analysis of Angles' administrative expenses also indicates that S15.000 per year has been spent on golf club fees for Max. Angles has been claiming these fees as a tax deduction each year, (10) BB's directors are of the view that they would need to incur debt to find the acquisition at an expected cost of about 6% per annum (11) Angles' financial statements for the last three years are presented below. They are prepared by a local suburban accounting firm who also provide taxation and other services for $15,000 per year. BB has its own in-house accounting and laxation staff (b) Based on the available information, to what extent might the acquisition of Angles be a good strategic move by BB? Angles Pty Ltd Income Statements The Years Ending 30 June 2015 $2,500,000 2016 $3,200,000 2017 $1,400,000 Sales/Commissions Less: Salary Costs Depreciation Entertainment Costs Other Administrative Costs Net Profit Before Tax Tax Expense/Benefit Net Profit After Tax (880,000) (50.000) (22,000) (596,000) (925,000) (50,000) (24,000) (650,000) (975,000) (50,000) (38,500) (770,000) 952,000 (285,600) $666,400 1,551,000 (465.300) $1,085,700 (433,500) 130.050 $(303,450) Angles Pty Ltd Balance Sheets As at 30 June Cash Accounts Receivable Supplies Inventory Intangibles PPE (Net) Total Assets 2015 304,400 120.000 35,000 392,000 450.000 1,301.400 2016 842.100 140,000 46,000 404.000 400,000 1.832.100 2017 (480,000) 470,000 48,000 410,650 350.000 798,650 Accounts Payable Loan Payable Total Liabilities 135,000 100,000 235.000 180,000 100,000 280.000 250.000 100.000 350.000 Share Capital Open. R. E. Profits Dividends Close R. E. Total Equity Total Debt & Equity $400,000 200.000 666.400 (600,000) 666,400 1,066,400 1,301,400 $400,000 666,400 1.085,700 (1,000,000) 1,152,100 1552.100 1,832,100 $400.000 1.152.100 (303,450) (800,000) 48.650 448,650 798,650 BB Pty Ltd (BB) is a large family owned, building company that operates in South Australia (1) Its operations are primarily directed towards the built-to-a-budget housing market associated with large land subdivisions and developments. The directors of BB are of the view that they are now ar a point in the company's growth where it would be advantageous to have some in-house architectural skills rather than just building to the plans of other developers. Another local company. Angles Pty Ltd (Angles). provides such services (iii) You have been contracted by BB to perform a due diligence on Angles as a potential acquisition target for BB. Your investigations to date reveal the following information about Angles: (1) Angles is owned by Max and Deidre Jones who are also the only two directors of Angles. Both Max and Deidre receive $25,000 per year for directors fees. In addition, Max receives a salary of $125,000 per year for management services and Deidre receives a salary of $40,000, although she is seldom at Angles. (2) Angles primarily provides architectural design and consultation services: approximately 60% of these services are for rich private customers for the design of their homes: 30% relates to commercial properties: and 10% is contract work for another builder who is currently a rival of BB's. Eight highly skilled architects are employed by Angles at an average salary in 2014 of 595.000 per year Your discussions with the staff indicate that the architects are proud of the quality of their work and like the challenge and prestige that comes from designing homes for some of South Australia's richest and greatest inhabitants. (3) Administrative expenses of Angles also include salaries for two part-time administrative staff ($50,000 in total). (4) Property, plant, and equipment primarily consist of office furniture, and computing equipment while the intangible assets are made up of special design software and capitalised interest. (5) The intangibles are not amortised and depreciation rates for PPE are derived from those specified for income tax purposes. (6) Angles loans are with Which Bank which has secured its interests with a mortgage over the assets of the business and Max and Deidre's home. The current interest rate on Angles' debt is 8% p.a (7) No provisions are made for doubtful debts because Angles' customers are very rich and famous. Discussions with Max and Deidre reveal that one of their customers (a well known radio personality) is suing Angles for alleged failures in the design of his home. Angles is refuting the claim and the matter is to go before the courts. Consultations with lawyers suggest that it will be at least two years before the matter is resolved and they are confident that there is about a 60% chance that Angles will win and pay no damages, a 30% chance that Angles will have to pay out $300,000, and a 10% chance that $450,000 will have to be paid. Legal fees are expected to average $80,000 over the next two years. It is possible that the matter might be settled out of court but this cannot be adequately predicted at present. As the whole issue is uncertain, there is no recognition of any related cost in the financial statements. (9) An analysis of Angles' administrative expenses also indicates that S15.000 per year has been spent on golf club fees for Max. Angles has been claiming these fees as a tax deduction each year, (10) BB's directors are of the view that they would need to incur debt to find the acquisition at an expected cost of about 6% per annum (11) Angles' financial statements for the last three years are presented below. They are prepared by a local suburban accounting firm who also provide taxation and other services for $15,000 per year. BB has its own in-house accounting and laxation staff (b) Based on the available information, to what extent might the acquisition of Angles be a good strategic move by BB? Angles Pty Ltd Income Statements The Years Ending 30 June 2015 $2,500,000 2016 $3,200,000 2017 $1,400,000 Sales/Commissions Less: Salary Costs Depreciation Entertainment Costs Other Administrative Costs Net Profit Before Tax Tax Expense/Benefit Net Profit After Tax (880,000) (50.000) (22,000) (596,000) (925,000) (50,000) (24,000) (650,000) (975,000) (50,000) (38,500) (770,000) 952,000 (285,600) $666,400 1,551,000 (465.300) $1,085,700 (433,500) 130.050 $(303,450) Angles Pty Ltd Balance Sheets As at 30 June Cash Accounts Receivable Supplies Inventory Intangibles PPE (Net) Total Assets 2015 304,400 120.000 35,000 392,000 450.000 1,301.400 2016 842.100 140,000 46,000 404.000 400,000 1.832.100 2017 (480,000) 470,000 48,000 410,650 350.000 798,650 Accounts Payable Loan Payable Total Liabilities 135,000 100,000 235.000 180,000 100,000 280.000 250.000 100.000 350.000 Share Capital Open. R. E. Profits Dividends Close R. E. Total Equity Total Debt & Equity $400,000 200.000 666.400 (600,000) 666,400 1,066,400 1,301,400 $400,000 666,400 1.085,700 (1,000,000) 1,152,100 1552.100 1,832,100 $400.000 1.152.100 (303,450) (800,000) 48.650 448,650 798,650