CASE STUDY

You, CPA, work for Conrad Consulting Ltd. It is now May 12, 20X2, and your boss, Marion Conrad, has just returned from a meeting. I have just met with George and Kelly of Sloan Industries Ltd. (SIL), Marion starts. SIL manufactures and retails wooden picture frames. The company was incorporated by George over 20 years ago. 10 years ago, Georges daughter, Kelly, became a part owner. Kelly has two young children of her own, and she hopes that one day they will show an interest in joining the family business as well. George currently owns 70% of the company and Kelly owns 30%. George is looking forward to retiring, and he and Kelly have been formulating a plan for the redemption of his shares. Georges shares are worth $4 million. He would like to redeem 50% within the next year, with the remainder redeemed in three to five years. George has been looking at ways to finance the redemption. He has been in discussions with the bank as SILs line of credit is currently up for renewal. The bank has requested the 20X2 draft statements (Appendix I and II). It has indicated that, provided that SILs financials are still in line with the industry, it will be willing to renew the existing line of credit or offer a term loan to replace it. While considering this as an option, George dislikes the personal guarantees that are currently in place on the line of credit and is wondering about using SILs property, plant, and equipment as collateral in place of guarantees. The banks proposals, as well as an additional option presented by George, are included in Appendix III. I have also reviewed the financial statements and gathered information on industry standards (Appendix IV), Marion continues. As the bank will be looking to analyze SILs financial situation, particularly in comparison to competitors, please prepare a ratio analysis and a vertical analysis for 20X1 and 20X2. You should include in your memo explanations and recommendations based on these analyses. Additionally, if there are ways that SIL can improve its working capital management, please discuss and explain how this could reduce the line of credit, supported by dollar values where possible. Finally, I would like you to analyze the quantitative and qualitative aspects of the current financing proposals. Be sure to consider the impact of each of these proposals on the financial statements and make a recommendation on which proposal to accept. Please prepare a draft memo to the Sloans with the results of your analysis. Your response, not including Excel (if applicable), should not exceed 1,800 words. Chartered Professional Accountants of Canada, CPA Canada, CPA are trademarks and/or certification marks of the Chartered Professional Accountants of Canada. 2019, Chartered Professional Accountants of Canada. All Rights Reserved. Les dsignations Comptables professionnels agrs du Canada , CPA Canada et CPA sont des marques de commerce ou de certification de Comptables professionnels agrs du Canada. 2019 Comptables professionnels agrs du Canada. Tous droits rservs. 30/10/18 Core 2 Week 8 Practice Case Case Appendix I Sloan Industries Ltd. Draft statement of earnings for the years ending April 30 (in C$000s) Head Retail Manufacturing office 20X2 20X1 Sales $ 10,402 $ 22,618 $33,020 $29,482 Cost of sales (Note 1) 5,513 15,154 20,667 17,984 Gross profit 4,889 7,464 12,353 11,498 Expenses Facilities 1,416 2,119 3,535 3,491 Office administration 482 1,119 1,601 1,483 Sales and marketing 1,782 2,044 3,826 3,614 Head office costs 1,419 1,419 1,327 Total expenses 3,680 5,282 1,419 10,381 9,915 Operating income (loss) 1,209 2,182 (1,419) 1,972 1,583 Interest costs 318 464 782 521 Income before taxes 891 1,718 (1,419) 1,190 1,062 Income taxes (25%) 298 266 Net income $ 892 $ 796 Statement of retained earnings Balance beginning of year $ 880 $ 294 Net income 892 796 Dividends (210) (210) Balance end of year $ 1,562 $ 880 Note 1: Approximately 50% of the manufacturing divisions cost of sales is for wood materials. 2 / 5 Core 2 Week 8 Practice Case Case Appendix II Sloan Industries Ltd. Draft balance sheet as at April 30 (in C$000s) 20X2 20X1 Assets Current assets Cash $ 16 $ 21 Accounts receivable (Note 1) 9,631 7,370 Inventories Manufacturing 3,588 2,272 Retail 918 835 Prepaid expenses 117 94 Total current assets 14,270 10,592 Property, plant, and equipment (Note 2) 3,767 3,626 Total assets $ 18,037 $ 14,218 Liabilities Current liabilities Bank indebtedness $ 5,572 $ 3,800 Accounts payables and accrued liabilities 10,511 9,158 Income taxes payable 122 110 Total current liabilities 16,205 13,068 Shareholders equity Share capital 270 270 Retained earnings 1,562 880 Total shareholders equity 1,832 1,150 Total liabilities and shareholders equity $ 18,037 $ 14,218 Note 1: SIL offers its manufacturing customers 60-day payment terms on receivables. Credit is not extended to retail sales customers. Note 2: Fair market value is $12 million. 3 / 5 Core 2 Week 8 Practice Case Case Appendix III Financing proposals 1. Line of credit The company has a line of credit from the bank that has a general security over all of the assets of the company along with the shareholders personal guarantees. The total maximum amount available on this line of credit is $6 million. The line of credit is callable on demand at the banks option. The loan bears interest at prime plus 3% and is up for renewal in June 20X2. The prime bank lending rate is currently 3%. 2. Five-year term loan The bank is also prepared to offer a long-term loan secured by the companys property, plant, and equipment for up to $4 million. The term loan would be for five years and bear interest at 6%. Interest only is payable monthly, with the principal due at maturity in June 20X7. 3. Strategic partner Charles Wong SIL currently purchases 75% of its wood materials from Original Woods Inc. (OWI), owned by Charles Wong. SIL has been purchasing wood from OWI for the past two years. Charles deals primarily with George and has yet to meet Kelly. Charles would like to become a strategic partner in SIL. In return for 35% ownership in the company, Charles will pay $2 million and OWI would sell wood materials to SIL at a discount of 10% from current costs paid by SIL. In return, Charles would be involved in the company as an executive manager and have a seat on the Board of Directors. 4 / 5 Core 2 Week 8 Practice Case Case Appendix IV Industry standards 1. Industry standards are as follows: Retail Manufacturing Current ratio 1.4 1.4 Quick ratio 1.0 1.0 Days sales in receivables No receivables 57 days Annual inventory turnover 8x 6x 2. Vertical analysis of the balance sheet: Average industry percentages (percentage of assets) Cash 3% Inventories 20% Long-term debt 20% 3. Vertical analysis of statement of earnings: Average industry percentages (percentage of sales) Retail Manufacturing Gross margin 45% 30% Facilities 15% 11% Selling and marketing 20% 10% Head office costs 9% 9%