Just-for-Choux Patisserie SARL (JCPS) is a small French company, specialising in bakery products. It is based in the Loire Valley. The Board of Directors are all family members and between them, they own 100% of the equity.
JCPS is profitable and is now seeking finance for a planned expansion. A local bank, ArgentInc has indicated that it may be prepared to offer a loan of €250,000 at a fixed annual rate of 10%. JCPS would repay €62,500 of the capital each year for the next four years. Annual interest would be calculated on the opening balance at the start of each year.
Current financial information on JCPS is as follows:
Current revenue: €525,000
Operating profit margin: 20%
Annual taxation rate: 20%
Average overdraft: €40,000
Average interest on overdraft: 5% per year
Dividend payout ratio: 50%
Shareholders’ funds: €300,000
Market value of non-current assets €180,000

As a result of the expansion, revenue would increase by €70,000 per year for each of the next four years, while the operating profit margin would remain unchanged. No taxation allowances would arise from investment of the amount borrowed (i.e. no capital allowances).

JCPS currently has no other debt than the existing and continuing overdraft and has no cash or near-cash investments. The non-current assets consist largely of the bakery from which the company trades. The current dividend payout ratio has been maintained for several years.

Required:
1. Assuming that JCPS is granted the loan from the bank on the terms indicated, prepare the income statement forecasts and calculate the following ratios for JCPS for each of the next four years (show all workings):
• interest cover
• financial gearing
• return on capital employed
• return on equity

2. Critically evaluate the financial implications for JCPS of accepting the bank loan on the terms indicated, using the figures you have calculated from Requirement 1 together with any other calculations you consider appropriate. You can assume that the retained profit each year is cash.