Case B - Stegmart 1 Case B Stegmart Projecting Financial Requirements Angela Martin is a sophomore English major attending the University of Victoria in British Columbia. She is president of the journalism club, which is where she first met her room and good friend Ashlie Stegemoller. Stegemoller is a junior computer science major. Martin and Stegemoller have been discussing the possibility of a new business venture. After months of brainstorming, they have agreed to start a venture that would offer students and local businesses help in preparing term reports. Both young entrepreneurs recently attended a local seminar entitled, How to Start a New Business. From this experience, they realized the need for preparing pro forma financial statements to obtain necessary financing and also to help them better visualize the merits of the venture. Research Findings Research indicates an unfulfilled demand for quality report-preparation services on campus. Market projections estimate a potential volume of 19,200 reports a year from University of Victorias students. Additionally, there are over 100 small businesses within two kilometres of the university that have indicated an interest in the service. The majority of the students are enrolled in classes that require two or three reports each semester, ranging from 5 to 50 pages in length. The ventures secondary target market consists of businesses in nearby Victoria, which has a population of approximately 150,000. There are two office building complexes within two kilometres of the university, each containing over 50 small businesses. Statement of Financial Assumptions Drawing on their findings, Martin and Stegemoller have made the following observations: 1. Sales projections related to the preparation of student reports and term papers are based on the following assumptions: Case B - Stegmart 2 a. Eighty percent of the 12,000 students at the university, or 9,600 students, prepare at least two reports each 12-month period. This gives a projection of 19,200 reports (9,600 2 = 19,200). b. The firm will get 3 percent of the student market in the first year, which will increase to 5 percent and 7 percent in the following two years, respectively. c. Student reports will average 16 pages in length, for which the firm will receive $20 per report. 2. Revenue forecasts associated with the businesses needing the firms services are based on the following assumptions: a. Sixty percent of the 100 local businesses will need at least 10 reports each 12-month period. b. The firm will obtain 6 percent of the business market in the first year, which will increase to 10 percent and 12 percent in the following two years, respectively. c. Business reports will average 30 pages in length, for which the firm will received $40 per report. 3. On average, students will want one copy of their report in addition to the original; businesses will want five copies. The firm will charge $0.06 a page for copies. 4. Practically all copies of reports will be bound, for a charge of $1 per copy. 5. The effective income tax rate will be 20 percent. 6. The firm will extend credit to its business customers. Accounts receivable should be about 15 percent of annual business sales, and inventories should run about 12 percent of annual total sales. However, supplies are expected to provide credit to the firm, which is estimated at 6 percent of annual sales. 7. The average cost of producing each report is estimated to be $12 in labour and $0.50 in materials. Martin and Stegemoller have an option for a rent-free office in the universitys student activities building. This arrangement was negotiated based on an understanding that they will provide the university with a special pricing schedule after 12 months of operations. The initial operation will include two personal computers with word-processing, spreadsheet, and database software. One laser printer and two photocopying machines will also be needed. The total equipments costs will be as follows: Computers $12,000 Printers and copiers $ 5,000 Total equipment costs $17,000 The equipment will be depreciated on a straight-line basis over a five-year life expectancy. Case B - Stegmart 3 Financing is expected to come from the following sources: As the founders, Martin and Stegemoller will each invest $2,000 in the business. Additional equity will be raise in the amount of $4,000 from an outside investor: $3,000 will be invested at start-up and the remaining $1,000 at the conclusion of the first year of operations. TD CanadaTrust has agreed to loan the firm $3,000 to be repaid within one year, but with the option to renew each year, provided the business is doing well. The interest rate is expected to be 9 percent. The $17,000 in equipment will be purchased with a down payment of $7,000; the remaining balance will be paid off at $2,000 in principal per year, plus interest due on the remaining balance at an interest rate of 10 percent. Question 1. Given the above information, help Martin and Stegemoller prepare pro forma income statements, balance sheets, and cash flow statement for the first three years of the operation.