MAC & MASTER BAKERY LTD$.$

It is January $3,2019.$ You, CPA, operate as a sole practitioner. Jason Yao, the owner of Mac & Master Bakery LTD$.($M&M$),$ has approached you for some advice.

M&M has operated in the town of Kentville, Nova Scotia for over $40$ years. Initially, the company sold its products directly to customers in the local community. Over time, the company expanded and now relies mainly on the sales of baked goods to grocery chains and locally owned convenience stores. As a result, transportation costs have risen directly as a result of the additional sales.

Jason is in the middle of negotiations with Loblaws, a large chain of grocery stores. He is wondering whether the contribution margin generated by this potential contract would be positive and whether he should accept the Loblaws deal.

Jason is considering acquiring some additional equipment to be paid for and placed in service at the very beginning of $2020$ that will increase M&M$$s baking capacity by $10\%$ for each of the next three years. M&M$$s bank is willing to lend an amount equal to approximately $65\%$ of the cost of the new equipment. In addition, they require the loan to be repaid over three years with annual equal principal repayments starting June $30$ plus interest calculated at $5\%$ interest per annum. Jason is worried that M&M will not be able to make the repayments over such a short period of time and has asked you to prepare a cash flow projection for each year the debt is outstanding to support his decision.

Jason has asked you to prepare a report that addresses his concerns. In order to assist you, Jason provided you with additional information $($Appendix I$)$ and a copy of M&M$$s draft financial statements $($Appendix II$).$

APPENDIX I

ADDITIONAL INFORMATION

Loblaws is M&M$$s biggest customer, currently generating $35\%$ of its sales. Another large grocery chain, Sobeys, is the company$$s next largest with $25\%.$ The remaining $40\%$ of sales is attributable to small convenience store sales. Those sales breakdowns are expected to remain stable for the next few years. If the deal with Loblaws goes through, it would result in a $60\%$ increase in current sales to Loblaws.

Unfortunately, the bakery is now operating at full capacity so the increase in sales to Loblaws would have to be offset by a proportional decrease in sales to the small convenience stores. In the absence of the Loblaws deal, M&M$$s total revenue and costs in $2019$ are expected to remain unchanged from $2018$ due to the capacity constraint.

The products sold to Loblaws and Sobeys have, on average, direct material and direct labour costs of $47\mathrm{.}5\%$ and $10\%$ of the selling price, respectively. On the other hand, products sold in the convenience stores have, on average, direct material and direct labour costs of $55\%$ and $20\%$ of the selling price, respectively. As a result of recent union negotiations, starting in $2020,$ labour costs for the sales to grocery store chains are expected to increase by $4\%$ per annum for the next three years.

The new equipment $($CCA class $53)$ will cost $$1$ million and have an expected useful life of ten years.

Besides the proposed new equipment purchase, no additional property, plant, and equipment acquisitions are expected in the next four years. Starting in $2020,$ projected CCA deductions for the existing equipment are as follows: $$390,000,$ $$330,000,$ and $$270,000.$

M&M$$s long$-$term debt was renegotiated in July $2018$ at a new interest rate of $5\%$ per annum. The balance of $$2,250,000$ is to be paid off evenly over $10$ years, starting June $2020.$

The general inflation rate is expected to be $2\%$ per annum starting in $2020.$ M&M is taxed at a total of $15\mathrm{.}5\%$ on business income below $$500,000$ and $26\mathrm{.}5\%$ on business income above $$500,000.$

APPENDIX II DRAFT FINANCIAL STATEMENTS

M&M BAKERY INC. INCOME STATEMENT For the year ended December $31($unaudited$)2018$

Revenue $ $11,497,500$

Cost of sales $$ raw materials $5,806,200$

Cost of sales $$ labour $1,609,700$

$7,415,900$

Gross profit $4,081,600$

Expenses

Advertising and promotion $475,000$

Salaries and wages $320,000$

Transportation $2,043,100$

Telephone and communication $120,000$

Professional fees $50,000$

Utilities $201,000$

Other $77,500$

$3,286,600$

Operating income $795,000$

Amortization $450,000$

Gain on sale of assets $(160,000)$

Interest on long$-$term debt $115,000$

Income before income taxes $390,000$

Income tax expense $58,100$

Net income $ $331,900$