HD Ltd. Daniel has taken over as the new Controller of HD Ltd. Inc, a revolutionary manufacturing business in BC. Despite not having a solid accounting background, Daniel is looking to lead the way in making some long-overdue changes to the organization. He has been with HD Ltd. for almost three years, so he has some ideas on how to improve processes. Daniel's direct supervisor, Tara, also doesn't have an accounting background. When the previous CFO retired suddenly last month, Tara was immediately promoted to the Chief Financial Officer role. She, in turn, promoted Daniel, who had been in the finance department and had helped her with a few projects, to Controller. The Controller role was a new one created by Tara to help deal with the company's growing accounting demands. Since Tara had worked as an administrative assistant to the previous CFO for five years, Daniel had assumed she was fit to take over. Still, he is wondering if perhaps the company lacks accounting expertise/leadership. Seeing how the only other accounting employee in HD Ltd. is Joe, an Accounting Assistant working under him, Daniel wonders if an external candidate would be better suited for his Controller role. The first thing for Daniel is to complete the budget for the year 2022. Because of the sudden leave of the CFO, the budget for 2022 is not finished. HD Ltd. Inc. has completed all operating budgets other than the income statement for 2022. Selected data from these budgets follow. Sales: $300,000 Purchases of raw materials: $145,000 Ending inventory of raw materials: $15,000 Direct labor: $40,000 Manufacturing overhead: $73,000, including $3,000 of depreciation expense Selling and administrative expenses: $36,000, including depreciation expense of $1,000 Interest expense: $1,000 Principal payment on note: $2,000 Dividends declared: $2,000 Income tax rate: 30% Other information: Assume that there are no work-in-process or finished goods inventories. Year-end accounts receivable: 4% of 2022 sales. Year-end accounts payable: 50% of ending inventory of raw materials. Interest, direct labor, manufacturing overhead, and selling and administrative expenses other than depreciation are paid as incurred. Dividends declared, and income taxes for 2022 will not be paid until 2023. HD Ltd. Balance Sheet December 31, 2021 Assets Current assets Cash $20,000 Raw materials inventory 10,000 Total current assets 30,000 Property, plant, and equipment Equipment $40,000 Less: Accumulated depreciation 4,000 36,000 Total assets $66,000 Liabilities and Stockholders Equity Liabilities Accounts payable $5,000 Notes payable 22,000 Total liabilities $27,000 Stockholders' equity Common stock 25,000 Retained earnings 14,000 Total stockholders' equity 39,000 Total liabilities and stockholders' equity $66,000 Daniel wants to prepare budgeted financial statements, but he needs some help. HD Ltd. is considering an investment of $130,000 in new equipment. The new equipment is expected to last ten years. It is estimated to have a zero salvage value at the end of its useful life. HD Ltd. expects the same total net cash flows of $240,000 over the life of the investment. But, because of declining market demand for the product over the life of the equipment, the net annual cash flows are higher in the early years and lower in the later years, as below illustration: Daniel has to determine whether to add new equipment or not. The required return is 12% for HD Ltd. Tara mentioned the critical of the loan from the Bank. Accepting the opportunity would mean an immediate investment of $130,000 by HD Ltd. Those funds can be borrowed from the Bank at a rate of 5% per annum. Daniel recalled the email from the bank manager as follows: COVENANT COMPLIANCE The undersigned certifies that they have not contravened any of the terms and conditions of the Bank's credit facility pursuant to the Facility Letter and that they are in compliance with the following financial covenants and the other conditions stipulated therein. 1. Total debt to tangible net worth ratio not to exceed 2.00 to 1.00. Actual ___________ Assumed Net Annual Discount Factor Year Cash Flows 12% (1) (2) 1 $34,000 .89286 2 30,000 .79719 3 27,000 .71178 4 25,000 .63552 5 24,000 .56743 6 22,000 .50663 7 21,000 .45235 8 20,000 .40388 9 19,000 .36061 10 18,000 .32197 $240,000 2. Current ratio to be maintained at a minimum of 1.45. Actual ___________ The bank manager said the ratios could be based on the budgeted financial statement for the year 2022 without the new equipment. Daniel's new contract promises that he will receive, as a year-end bonus, 1% of all growth in HD Ltd.'s pre-tax net income over the prior year. Hence, he is excited about expanding operations and taking on the equipment. He is also wondering if there are certain accounting policies that can be implemented to increase income on paper, even if no significant changes are made in the business. Advise Daniel on his career path and the current outlook on HD Ltd. Produce a business report, including comprehensive analysis, recommendations, and any questions you may need to ask your client.