InnovAppliance, a dynamic and innovative small-scale home appliance manufacturing company based in Vancouver, Canada, has experienced remarkable success in the domestic market. Renowned for its cutting-edge designs, energy efficiency, and integration of artificial intelligence technology, InnovAppliance is now set to expand into new markets. The companys CEO, Peter Gallagher, has identified an opportunity to expand into the thriving Israeli market. However, this expansion requires additional funds that the company must raise through either debt or equity financing. As the CFO of InnovAppliance, your role is to evaluate the various issues below, provide recommendations on the expansion and optimal financing approach, and address the ethical dilemma of sustainability in the expansion process. InnovAppliance has captured consumers attention with its game-changing home appliances that combine functionality, style, and the power of artificial intelligence. These smart appliances incorporate advanced AI technology, enabling users to interact with their appliances through voice commands, smartphone apps, and intelligent automation. For instance, the company's AI-powered refrigerator uses computer vision to recognize and track food items, provide recipe suggestions, and optimize energy usage based on user preferences. Having experienced some recent blood pressure concerns, Peter is especially interested in using this functionality to help motivate him on his own journey towards living a healthier lifestyle and has recently launched a new marketing campaign using the slogan MotivAte Me. He is worried that the company is spending too much on marketing but believes this will pay off in the long run. The companys AI-enabled home appliances have attracted widespread acclaim for their ability to enhance convenience, energy efficiency, and user experience. With a focus on energy efficiency and sustainability, InnovAppliance has become a trusted brand among environmentally conscious consumers. InnovAppliance's most recent set of financial statements is included in Appendix A. Expansion: With the domestic market becoming increasingly competitive, InnovAppliance has identified Israel as a promising market for its products. Israel boasts a growing economy, a tech-savvy population, and a strong demand for smart home appliances. By expanding to Israel, the company aims to tap into new customer segments and leverage the country's tech-oriented culture. The CEO believes that establishing a presence in Israel will enhance the companys global footprint and strengthen its position as an international player in the home appliances industry. However, at the most recent board meeting, the Chairman of the Board, Lars Ericsson, has voiced some concerns about expanding into Israel due to the financing required, cultural differences, quality concerns and regulatory considerations. The CEO would like an analysis and recommendations on whether the company should move forward with the expansion, with consideration towards both financial and non-financial factors. The companys controller has prepared a detailed breakdown of the incremental start-up costs, and a 5-year projection of revenue and operational costs associated with the expansion in Appendix B. Model X: InnovAppliance has recently invested in new artificial intelligence (AI) technology to produce a new refrigerator model called Model X. The new technology would automatically determine when to order new groceries based on customer eating habits. This technology aims to enhance customer convenience and increase sales. The CEO has asked the Operations Director, Olu Manuel, to put together a quarterly sales, production, and direct materials budget for the first year of sales of this product line. Olu has provided the financial information in Appendix C, however has requested your assistance in building these budgets. He wants to understand why the company is spending so much time budgeting, and how these budgets can be used to make decisions and monitor the performance of the new product line going forward. Hes also looking for some guidance on whether the projected gross profit margins for the Model X look healthy in year 1 (2024), and some ideas on how the team can reduce their projected direct materials costs. Financing: To support the companys possible expansion and further investment in new technology, InnovAppliance will need additional funds. The company currently has a strong financial position, with healthy cash reserves and a positive operating cash flow. Furthermore, InnovAppliance has a good credit history and a favorable relationship with its existing lenders. There are currently two financing opportunities available to the company at this time, with the potential for additional financing at a later date. The CEO would like you to compare the two financing options and provide guidance on which one would be best for the company to pursue. Option 1: InnovAppliance has approached an Israeli bank to secure a loan for the expansion to Israel, or for use in further technological investment. The bank has offered a term loan of $2 million with an interest rate of 8% per annum. This bank is known for offering strict debt covenants and requires the company to maintain a current ratio of 2.2:1 at each financial reporting date. The loan has a repayment period of five years, and InnovAppliance would need to make equal monthly payments, including principal and interest. The loan requires collateral in the form of the company's manufacturing equipment, with a market value of $1.8 million. Option 2: InnovAppliance has engaged with venture capitalists interested in investing in the company's expansion. They have proposed an equity financing deal where they will invest $2 million in exchange for a 20% ownership stake in InnovAppliance. The venture capitalists have a track record of supporting successful technology companies and can bring valuable industry expertise and networks to help accelerate InnovAppliance's growth. Ethical Dilemma: InnovAppliance's commitment to sustainability has been a core value since its inception. As the company considers expansion into Israel, it faces an ethical dilemma regarding the sourcing of raw materials. Given some of the shrewd business practices in Israel, the current supply chain involves materials sourced from suppliers who do not meet InnovAppliance's stringent sustainability standards. As CFO, you must decide whether to compromise on sustainability principles and work with these suppliers to keep costs low or seek alternative suppliers who adhere to sustainable practices, potentially incurring substantially higher costs. In making the decision, careful evaluation of the long-term implications of each option must be considered. You have been asked to consider the potential effects on the company's brand image, customer loyalty, and market positioning. Consideration should also be taken towards the impact of sustainability decisions on stakeholders such as employees, customers, and investors, who increasingly prioritize sustainability and expect businesses to act responsibly. The decision the company makes will not only shape InnovAppliance's expansion to Israel but also influence the company's standing as a socially responsible corporation. Required: The CEO would like an analysis that details all the issues discussed above with clear recommendations, so that the findings can be presented to the board of directors. Since these important business decisions must be made quickly, if certain details are not available in the financial information provided, the CEO expects assumptions to be made. APPENDIX A: InnovAppliance Financial Statements InnovAppliance BALANCE SHEET December 31, 2022 2022 2021 ASSETS Current Assets Cash $600,000 $500,000 Accounts Receivable $400,000 $300,000 Inventory $900,000 $700,000 Total Current Assets $1,900,000 $1,500,000 Land & Buildings $2,000,000 $2,000,000 Equipment $1,800,000 $1,500,000 Intangible Assets $200,000 $200,000 TOTAL ASSETS $5,900,000 $5,200,000 LIABILITIES Current Liabilities Accounts Payable $500,000 $400,000 Accrued Expenses $150,000 $100,000 Unearned Revenue $200,000 $200,000 Total Current Liabilities $850,000 $700,000 Long-Term Debt $700,000 $800,000 TOTAL LIABILITIES $1,550,000 $1,500,000 SHAREHOLDERS EQUITY Common Stock $500,000 $500,000 Retained Earnings $3,100,000 $2,700,000 Additional Paid-in Capital $750,000 $500,000 Shareholders Equity $4,350,000 $3,700,000 TOTAL LIABILITIES & SHAREHOLDERS EQUITY $5,900,000 $5,200,000 InnovAppliance INCOME STATEMENT For the period ending December 31, 2022 2022 2021 Revenue Sales Revenue $4,800,000 $3,700,000 Service Revenue $200,000 $300,000 Total Revenue $5,000,000 $4,000,000 Cost of Goods Sold $2,800,000 $2,200,000 Gross Profit $2,200,000 $1,800,000 Operating Expenses Salaries & Wages $700,000 $600,000 Rent & Utilities $250,000 $200,000 Marketing Expenses $400,000 $300,000 Other Operating Expenses $150,000 $100,000 Total Operating Expenses $1,500,000 $1,200,000 Operating Income $700,000 $600,000 Interest Expense $50,000 $60,000 Income Before Tax $650,000 $540,000 Tax Expense $195,000 $162,000 Net Income $455,000 $378,000 APPENDIX B: Expansion - Financial Details The controller has put together some projections associated with the expansion into Israel. The breakdown of the expected start-up costs for this project include: Equipment: The company plans to rent their manufacturing space, but would need to incur $1,000,000 for the purchase of new equipment. Marketing and Advertising Expenses: InnovAppliance plans to allocate $500,000 for marketing and advertising campaigns targeted at the Israeli market. This includes promotional activities, market research, and advertising campaigns to create brand awareness and attract customers. Research and Development Costs: Over the last 2 years the company has spent $185,000 on travel and research & development related costs. To adapt the products for the Israeli market and meet local regulatory requirements, InnovAppliance anticipates incurring another $300,000 in research and development costs. This includes product modifications, certifications, and testing. Distribution and Logistics Expenses: Establishing distribution channels and ensuring efficient logistics in a new market involve additional costs. InnovAppliance estimates that it will need to allocate $200,000 for distribution network setup, transportation, warehousing, and order fulfillment in Israel. Legal and Regulatory Fees: Expanding into a new country requires legal and regulatory compliance. InnovAppliance expects to spend $100,000 on legal and regulatory fees for market entry, permits, licensing, and compliance with Israeli regulations. Administrative Costs: Additional administrative costs are anticipated for managing operations in Israel. These costs include setting up a local office, hiring local staff, and complying with local administrative requirements. InnovAppliance estimates that it will need to allocate $150,000 for administrative expenses associated with the expansion. Financing costs: Depending on the financing option the company decides to pursue, there could be additional interest expense that the company will need to incur. The revenue projections for the expansion into Israel in the first 5 years are as follows: Year 1: InnovAppliance expects to generate $3 million in revenues from the Israeli market. Year 2: The company anticipates a growth rate of 20% in the Israeli market. Year 3: The company projects further growth of 15% in the Israeli market. Year 4 & 5: The company expects 10% growth per year. Going forward if the company uses the new cheaper Israeli suppliers, they expect the gross profit % to increase by 8% in comparison to the 2022 operations in Canada. Annual labor costs are 10% higher in Israel, however the remaining operating expenses are expected to fall in line with the same % of sales as Canadian operations. The Israeli tax rate is expected to be 50% of the Canadian tax rate. APPENDIX C: Model X Budget Information The Operations Director has provided the following financial details to assist in the preparation of the requested budgets for the first year (2024). Expected Q1 sales volume: 1,000 units with a 15% increase each quarter in 2024. Q1 sales for 2025 are expected to be the same as Q4 sales in 2024. Selling price per unit: $1,000 in 2024, and $800 in 2025 Raw materials cost per pound: $10 Volume of raw materials per unit: 50 pounds Direct labor cost per unit: $200 Variable manufacturing overhead cost per unit: $100 Fixed manufacturing overhead cost per year: $300,000 Selling and administrative expenses per year: $200,000 Desired ending raw materials inventory: 20% of next quarters expected production requirements. The desired ending raw materials inventory at the end of Q4 2024 is 16,202 pounds. Desired ending finished goods inventory: 30% of next quarters expected sales units