George Coffin Jr. is the sole owner of the Coffin Vault Company in Duluth, MN. He inherited the company from his father. He has no children. Coffin is 60 years old and has decided that he wants to sell the company to his employees by creating an ESOP (Employee Stock Ownership Plan). He has 100 employees, and each employee would get one share of stock in the company. Each employee would be required to buy the share of stock for $10,000 to give the company $1,000,000 in cash as operating cash on hand. The employees cannot sell their shares until 2027. All employees have accepted the terms of the agreement by giving the company treasurer their checks for $10,000.

Coffin Vault makes high-end burial vaults using reinforced concrete. Each vault is self-sealing with a base and a cover that fits over the coffin when it is placed in a grave. The vault protects the gravesite from sinking. Without a vault, the coffin could collapse from the weight of the dirt above it. Under state and federal law, cemeteries cannot require the use of a vault, but most families buy one because they are encouraged to do so when they make funeral arrangements.

Coffin vaults cost $10,000 each, but the materials to make them only cost $2,500. Labor and other administrative costs add an additional $5,000 to the cost of each vault. Annual sales for the company in 2020 totaled $10,000,000, and sales are expected to grow by 10 percent per year for the next five years. The cost of materials would increase by 5 percent per year for five years. And salaries for employees would remain the same for five years, under the terms of the ESOP, which means that labor and administrative costs would remain at $5,000 per vault.

Using the information above, start to create an annual income statement for 2020.

QUESTION 1 What is EBIT for the company in year 2020?

QUESTION 2 Based on the information above, are employees getting a good deal for their $10,000 initial investment? Remember employee wages will be frozen for five years.

As you work through the problem, you will need to construct pro-forma annual statements for the six years, 2021 through 2026.

QUESTION 3 What is the proforma EBIT for each year from 2021 through 2026?

QUESTION 4 What are the sales projections for each year between 2021 and 2026 based on the information above.

Coffin Vault pays federal corporate taxes of 25 percent and corporate state taxes of 18 percent. In addition, the company pays 7.06 percent in Social Security taxes for the employees. (Use labor and administrative costs as the basis for Social Security calculations.)

Coffin Vault has assets of $5,000,000 in buildings and equipment. The company has no debt, and the buildings and equipment have been fully depreciated. The ESOP will be able to claim depreciation on $5,000,000 in fixed assets beginning in 2021 because it is a new company buying the fixed assets of Coffin Vault.

The ESOP will be buying the company from George Coffin.

Here are the terms of the Dec. 31, 2020, sale agreed upon by Coffin and the employees:

1. George Coffin received $5,000,000 in cash from the ESOP at the time of sale on Dec. 31, 2020. The company had $3,000,000 in retained earnings that went to Coffin. The ESOP raised the additional $2,000,000 by borrowing $2 million from a local bank at 7% interest for five years. The ESOP will make 10 equal payments to the bank. Payments will be due every six months beginning on July 1, 2021.

2. George Coffin will receive 20% of the annual depreciation allowance beginning on Feb. 1, 2022. The payments will continue until the buildings and equipment are fully depreciated. Use the 5-year MACRS on page 398 in the textbook to answer the questions that follow the terms of the sales agreement.

3. In 2027, After the final payment from annual depreciation is made, Coffin will receive $3 million if the annual sales revenue has reached $16 million in 2026. The $3 million cash payment will be made in April 2027. Coffin believes the likelihood of the company reaching the $16 million sales figure is 90%.

QUESTION 5 Calculate the Present Value of George Coffins whole package.

QUESTION 6 Calculate the Net Present Value of the annual payments to Coffin from depreciation.

QUESTION 7 If George Coffin does not spend any of the initial $5 million cash payment for five years, what would the future value of a balanced stock and mutual funds portfolio be if he were able to earn 8% per year.

QUESTION 8 If he invested the money at 8%, he would have to pay 21% in federal income taxes plus 10% in state income taxes on his earnings. Would he be better off investing in Minnesota tax-free bonds earning 4% than investing in taxable securities earning 8 percent? Explain why.

QUESTION 9 If George Coffin were risk averse, which investment portfolio would be safer the Minnesota bonds that are rated AA and AAA or the balanced stock and mutual fund portfolio with a Beta of 1? Explain your answer.

QUESTION 10 In your opinion, is George Coffin getting a good deal for his company? Explain your answer.

QUESTION 11 Based on the package negotiated by George Coffin with the ESOP, are the employees getting a good deal? Explain your answer.

When you prepare your annual financial reports, you will determine a figure for earnings per share for the years from 2021 to 2026. Each employee will receive an annual payment of 50% of the earnings per share. Remember each employee owns one share of stock.

QUESTION 12 What would an employee earn from the companys earnings per share each year?

The remainder (50%) of the earnings per share will be deposited into a sinking fund at 8 percent interest to offset the cost of the $3 million payment to George Coffin in 2027.

QUESTION 13 Will the fund have enough money to make the $3 million payment to George Coffin? If not, how much will the ESOP have to borrow to make the payment?