Nova Bakery Ltd. is a specialty bakery manufacturer located in Scarborough Ontario. The

company was founded by Rick and Peter Wiley in 2015. Due to high competition, the company

has been struggling to maintain profitability. You are the newly hired CFO and

you are mandated

to look at the following situation and provided a recommendation what Nova should do:

Exhibit 1 provides you with information regarding 2 products Nova currently produces. It

appears that the production of these products are near capacit

y. They want to determine a

production schedule that will optimize profit.

Exhibit 2 provides you with information regarding the possibility of leasing or buying a new

oven to meet the demand.

Exhibit 3 relates to an opportunity which Nova is asked to be

the sole supplier of raisin bread to

the UTSC Sports Arena for all their tournaments held . Rick and Peter are interested in knowing

if this opportunity will help to contribute to their bottom line.

Exhibit 1 : Cake and Bread Production

Nova is famous for its banana cake and raisin bread. It takes approximately 15 minutes to

batch of banana cake (40 loaves) and 30 minutes to prepare batch of raisin bread

(45 dozen)

The baking time for a batch of banana cake is 40 minutes, and for a batch of

raisin bread is

16 minutes. The oven can hold three batches of banana cake and or one batch of raisin

bread at a time. As required under health and safety legislation, the oven only operates 16

hours per day, 365 days a year. Right now, we seem to be oper

ating our oven at full

capacity and we are still having trouble keeping up with demand.

Batch components and yield:

Banana Cake

Raisin Bread

Variable cost per batch

$ 33.41

$ 38.75

Selling price per loaf

$ 3.29 per loaf

$ 3.09 per dozen

Demand:

Daily demand for our products is currently 2,400 loaves of banana cake and 990 dozen raisin

bread. Given the growing demand for our products, some of our customers are being shorted

on their orders. Some of these customers have voiced their concerns about

the impact this is

having on their businesses, and have threatened to take their business to a competitor if Nova

cannot service them effectively.

MAF 1002 - 2020 Summer

Mid Term Exam

Page 3

+ Ivey Case (Pages 1

-5)

Exhibit 2 - New Oven

Nova can lease the new equipment needed for its expansion for $125,000 annually

,

payable at the beginning of each year from January 1, 2021, to January 1, 2027 (seven

years). If we sign the lease in the next 60 days, we will receive $50,000 of the first year's

lease payments as a signing incentive and the leasing company will cover a

nnual

maintenance, estimated to be $15,000 per year.

The other option Nova could pursue would be to purchase the new equipment for

$550,000. That is a large sum of money, and I am concerned about the impact on cash flows,

but I am also uncertain about the

factors that come with leasing. Nova currently has a line of

credit at the bank and has sufficient room for the purchase of new equipment. The effective

after tax interest rate is 6%. Should Nova choose to sell the equipment

in 2027,

it is estimated

it will

be worth

10%

of its current

purchase

price.

The tax shield on the equipment, including accounting for the disposal, is $120,000.

Nova's effective tax rate is 30%.

The new oven has

recently been in the news as a number of parts have been recalled.

Replacement parts for this model of oven are not available locally, but the supplier assures

us the issue resulting in the recall has been addressed.

Exhibit 3 -

Special Order

The

UTSC

Sports

Arena has approached Nova

to supply a special type of raisin bread

for all events

hosted at the arena for a period of five years. The deal requires 50 dozen of raisin bread

per day,

at a discounted rate of $2.99 per dozen. If this level of service i

s not met,

Nova

would be subject

to a penalty.

As part of the agreement,

Nova

will be required to use the Bonnel flour

supplied by

a key sponsor

of the UTSC Sports Arena. B

onnel

is a local flour mill that is known for late delivery and quantity

discrepanc

y on its orders.

To meet the arenas demands we would need to invest in a specialized piece of equipment that

makes thes

e bread

. The

machine will cost $100,000 and requires annual recalibration at a cost of

$5,000 per

year.

This machine will take less time to produce a batch of raisin bread (45 dozen) which would reduce

the variable cost per batch of b

read

to $34.25 due to decreased labour costs. This machine comes

from Switzerland, and Nova

would have to bring over one of their technicians if it ever required

repair.

Nova

uses a 12% weighted average cost of capital when evaluating these types of investments.

The tax impact can be ignored for the purpose of this calculation