Glacier Beverage Company

It's December 23, 2019 and your boss, Siddig Fleming, has just dropped a large amount of files and other documents on your desk and left instructions for you. You notice at the top of the instruction sheet that he has marked the request as urgent. As a result, you set aside your other work and begin to leaf through the information.

Your firm is acting as a consultant to Glacier Bay Beverage Company (GBB), a publicly traded company located in Torbay, Newfoundland and founded by James McCarthy. GBB manufactures the famous McCarthy's beverage. Your firm has been a consultant to GBB for five years and you are the new senior consultant to this client. You were not originally assigned to GBB, but were given the task after the original consultant suddenly left for a job in the Caribbean. GBB's fiscal year end is December 31.

GBB is currently in a major expansion and is exploring its financing options for the acquisition of manufacturing equipment to be used in its beverage manufacturing facilities.

GBB is currently cash strapped, despite sales and production that have increased significantly over the past 10 years. All of its other key ratios are in good shape, allowing GBB to explore various ways to finance its next expansion. Founder and major shareholder James is concerned about maintaining a good cash and debt ratio, as he believes this will be important in the future and minority shareholders have expressed concern about these ratios in the past.

In addition, in order to fully understand the situation, GBB would like you to prepare journal entries for the first year for each of the three alternatives described below, and to describe the potential impact each will have on GBB's key ratios.

Your firm has been hired by GBB to help explore the various alternatives as described in Appendix I. The company is requesting your detailed analysis. This analysis should include calculations, financial statement impacts, and more qualitative impacts that you feel are appropriate under the circumstances (such as impact on corporate structure, leverage, advantages and disadvantages).

Work to be done

Prepare the draft report for GBB.

Appendix I - GBB Details

Details of the equipment to be purchased

The equipment in question is an ALPHA8K9 - Type II Beverage Bottling Equipment with a capacity to bottle 100 cases of iced tea per minute. The fair value of this equipment is $1.5 million.

The equipment is expected to have a useful life of 10 years, after which it could be sold for $100,000.

Technological obsolescence is a factor in this type of equipment, as manufacturers are always making them better, stronger and faster.

Note: Assume that the purchase of the equipment and the issuance of any debt or equity will occur on January 1, 2020.

Alternative #1

GBB could finance the equipment purchase by issuing bonds.

Bonds of $1,000 would be issued for a total of $1.5 million, for a period of 10 years at a contractual interest rate of 6%.

The market interest rate on similar bonds is currently 4%.

Interest would be paid semi-annually beginning July 1, 2020.

Alternative No. 2

GBB could purchase the equipment for $1.5 million and obtain a secured loan from its bank.

The terms of the loan require annual payments on the $150,000 principal beginning January 1, 2021.

Interest is to be paid annually on January 1 and is set at 8%, which is the market interest rate for this type of loan.

GBB is required to maintain a specified leverage ratio or the loan will become due immediately.

Alternative no. 3

GBB could issue common shares to finance the purchase of the equipment.

GBB is a public company, with the founding member holding 51% of the currently outstanding common stock (there are currently a total of 4.5 million shares outstanding).

The current market price is $15 per share.

You have been told that the auditors will be arriving in a few months and GBB has asked you to ensure that all accounting recommendations are in accordance with GAAP. In addition to the proposed equipment acquisition, GBB has a few other accounting items that management would like you to comment on before the auditors arrive. See Appendix II.

Appendix II - Other Details

During the year, a visitor to the facility slipped and fell on spilled iced tea and broke his leg. The visitor subsequently sued GBB for $800,000. GBB's attorneys do not believe the $800,000 lawsuit will be won by the plaintiff, but believe there is a 20% chance it will be dismissed, a 60% chance GBB will have to pay $200,000 and a 20% chance GBB will have to pay $400,000.

GBB intends to have a contest this year with a coupon attached to each tea product. Any customer who accumulates five coupons can send them to GBB and redeem them for a GBB T-shirt. GBB would like guidance on how to account for this transaction at year end once the contest is in effect.