Prepare Pro Forma 1996 and 1997 Financial Statements and conduct breakeven analysis to assess (1) breakeven $ sales, (2) whether CL could breakeven in 1996 or 1997.

47 Exhibit 1 SELECTED MARKET RESEARCH 1993 Ave. Annual Growth Rate Population Per Capita Income Per Capita Retail Sales 60,200 71,200 95,600 387,300 Huron County Porth County Oxford County Middlesex County (includes London) Eigin County Lambton County 1.03% 0.95% 1.62% 2.21% $ 14,600 16,100 16,400 19,000 $5,200 5,700 5,800 6,700 5,600 6,500 77,300 130,400 1.36% 0.65% 15,700 18,200 Number of Individuals in the Labour Force, Ontario, 1991. Number of Individuals in the Labour Force, London, 1991 Families in Private Households, Total, London, 1993.. Total Supermarkets and Grocery Retail Sales, Canada, 1993. Tourism Expenditure on Food and Beverage, London, 1989. Estimated Number of Tourists, London, 1993.... 5,511,235 169,245 102,935 ..$14.4 billion .$59.4 million .300,000 Sources: The London Visitors and Convention Bureau, The Financial Post, Statistics Canada 48 Part 1 An Assessment of the Firm and its Cash Needs Exhibit 2 ESTIMATED SEASONALITY AND AWARENESS FACTORS AND FORECASTED MONTHLY SALES Seasonality 0.70 0.85 0.95 Month April 1995 May June July August September October November December January 1996 February March 1.00 1.00 0.60 0.50 0.30 0.30 Awareness 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.8 0.8 0.8 0.8 Sales $ 9,266 21,146 34,808 48,470 60,350 43,718 42,530 29,462 29,462 24,710 24,710 34,214 0.25 0.25 0.35 $ 402,850 Total (fiscal year 1995-96) 0.8 0.8 0.8 April 1996 May 0.8 June 0.70 0.85 0.95 1.00 1.00 0.60 0.50 July 0.8 0.8 67,478 81,734 91,238 95,990 95,990 57,974 48,470 29,462 29,462 24,710 24.710 34,214 0.8 0.30 August September October November December January 1997 February March 0.30 0.25 0.8 0.8 0.8 0.8 0.8 0.25 0.35 $ 681,436 Total (fiscal year 1996-97) In September 1994, James and Serena Udderlie were preparing a loan application to a London, Ontario branch of the Confederation Bank of Canada. The Udderlies were requesting a $160,000 term loan, in addition to an operating loan, for the potential opening of a CL ice cream and clothing franchise in London. The Udderlics had a considerable amount of marketing research and cost estimates, and in order to complete the application, they needed to develop proforma income statements and balance sheets for the store's first two years of operation. They also planned to review carefully the qualitative characteris- tics of their idea in order to assess the chances of success of a franchise in London. The Udderlies also wondered what collateral, if any, they would be able to provide the bank to secure against a loan, and what other terms the bank might deem necessary. CL's HISTORY OF GL CL began in 1983 on Prince Edward Island (P.E.I.), Canada, as a single outlet producing and selling ice cream made from a time-honoured family recipe. However, the clothing with whimsical imagery that the staff wore as uniforms began attracting attention and the company soon expanded to include a retail line, which was 75 to 80 items deep by 1995. The retail line, which included such items as t-shirts, sweatshirts, pins and mooing cookie jars, was subsequently offered by mail order in 1991.C25 began **** under the supervision of Professor Steve Foerster sofely to pro need to illustrate either effective or inet mas and 43 fraichising with the opening of a store in Vancouver, British Columbia in 1993, and later opened stores in Park City, Utah and Whistler, British Columbia. Le sold only premium ice cream, with ingredients that included dairy fresh cream, sugar, fresh eggs and pure vanilla. Also, the ice cream included very little of the air found in most commercial ice creams to increase volume. All ice cream was served in a fresh waffle cone made at the ice cream counter in full view of the customers. When customers ordered their cone, they often selected from colourful names such as Customers were treated to a complete experience at CL. The staff were very friendly and were will ing to give customers a sample before they decided on an ice cream flavour. All stores were innovatively dec- crated to include clocks displaying both the local and P.E.I. time, as well as an ice cream menu shaped as a cow with a swinging tongue. But most important to the experience were the clothing items with witty satir- ical designs and captions COLS founder, Cobie Gable, still managed the company in July 1994. The company's creative director, Marc Gallant, a well-known P.E.I. artist, had recently passed away. While Gable was responsible for most of the business decisions that had brought Liis success, Gallant was the creative person behind the art work on the whimsical clothing. Gallant's creativity, inspired by his fascination with cows, was preserved by say ing many of his preliminary designs in - manner that could easily be manipulated by his creative team to develop new designs. JAMES AND SERENA UDDERLIE James Udderlic was the Director of Market Development in the Employee Benefits Division of the Provincial Life Insurance Company. He completed his MBA from the Western Business School in 1983 and joined Provincial in the same year. Although successful and happy in his current position, as James noted, "being an entrepreneur is in the back of the mind of most business school graduates." Serena Udderlie was a spe- cial education teacher who was currently volunteering one day a week while managing their three children full-time, including the youngest child who had not yet entered public school. Serena planned on returning to work full-time once their youngest child was in school. She received a Bachelor of Arts, Bachelor of Education and a Master of Education from the University of Western Ontario, and was the gold medalist while earning the Master's degree. Serena, like her husband, was excited to open up a family business. The Udderlies required that any business they started would neither affect James' commitment to Provincial Life nor their commitment to their family. While James and Serena accepted that changes would be necessary to the family routine, they did not want their children to suffer because of the business and discussed it with them before making a final decision. The Udderlies were under no illusions about the commitment they would have to make to the venture, but they anticipated that if they were to hire a full-time person to manage their investment," then the time requirement could be kept to a manageable level. They felt that their requirements could be met in London since the three locations, the tentative location of the store, Provincial Life and horne, would only be a short distance from cach other. James and Serena planned to incorporate, with each owning 50 per cent of the business. James would be responsible for strategic planning, finance and general management. Serena would take care of hiring the staff and marketing. They would both take turns meeting with their manager on a weekly basis to keep tabs on their investment," by reviewing results, setting store policy and planning promotions THE IDEA The idea for the 's franchise came about when the Udderlie family was camping on PE.1. in the summer of 1992. At that time, James saw a magazine advertisement for Clice cream that caught his attention. What struck James was the "wholesomeness of the layout that depicled a young boy wearing clothing with the distinctive motif and having fun cating ice cream. Later, their neighbours at the campsite said they enjoyed the store they visited, and after the Udderlies visited the store themselves, they were greatly impressed with Their Cow's experience. In particular, they noticed the interesting clothing and its displays, 44 Part 1 An Assessment of the Firm and its Cash Needs the store's layout, the friendliness of the staff and most importantly, the delicious ice cream. After the Udderlies inquired about franchising, a company representative told them that the first company franchise was to open later that summer in Vancouver, British Columbia and that no other franchises were being con sidered. The representative advised the Udderlies that if they were to write a letter outlining the desire to own a franchise, the company would get back to them. The Udderlies had a strong conviction that theCL concept would work in London. The first decision the Udderlies had to make was whether or not to invest time examining the feasibility of a franchise before taking the idea to a financial institution for possible financing. It was not until the summer of 1994 that the Udderlies decided to write to representatives, at which time they received avourable response inviting them to visit the company in PE.L. James traveled alome to PE.L. in July 1994 and spent three days meeting with the franchiser and learning more about the company. During this time, it became obvious to James that while I was a profitable business, a franchise had to want more than just profit from owning a store. The company's core values included a strong persuasion for quality and creativ- ity that made owning a store an expensive proposition. It was believed that only by following these valors would store have all the elements necessary for it to be successful. MARKET RESEARCH James brought with him to PEI. some preliminary market research that he had gathered from Statistics Canada, the Conference Board of Canada and the Convention Bureau of London. He felt that it was in this area that his MBA helped him most he knew how to differentiate the important information from the intelevant as well as how to deal with incomplete market information. From the research, he gathered two key pieces of information: gregate spending on take-out food in the London area and an estimate of the amber of visitors to London. The information in Exhibit I was meant to give James a sense of how many potential customers existed and the extent of their buying power. He focused on the counties around London James figured that his target segment would include tourists, local employed families and local non married, employed individuals over the age of 16. He believed that employment was an important characteristic of his target segment since the price point would be greater than the average price in the industry The population of London in 1994 was approximately 300,000. Using Information he received from the franchises, James figured that local monthly visits would be the product of both the specific month and the degree of local awareness of the store. For example, in the store's first month of operation, targeted for April 1995, he predicted that the seasonality factor would be 70 per cent versus a high of 100 percent in July and the awareness factor 10 percent, verres a high of 80 per cent by November. Since the product of these was seven percent, le figured that seven per cent of 300,000, or 21,000 people would be included in the predisposed base for the month of April. He then predicted that of the base one in twenty would visit the store. Hence, in the month of April, 1,050 individuals from the local population would visit In addi tion, James estimated that 120 tourists would visit the store each month. The predicted seasonality factor, the awareness factor and projected monthly sales are listed in Exhibit 2. The franchise also provided the Udderlies with frequency of purchase date, broken down by product, based on the experience in PEL and Vancouver. Only 10 per cent of all individuals that entered the store left without making any purchase of the remaining 90 per cent, 65 per cent purchased only ice cream, 10 per con purchased only a retail product, and 25 per cent purchased both James estimated that the average expen- ditures per customer would be two dollars for ice cream and $20 for retail. Using this methodology James estimated year one (April 1, 1995 to March 31, 1996) and year two (April 1, 1996 to March 31, 1997) retail sales to be $320,450 and 542,052, respectively, Ice cream sales were projected to be $82,400 and $139,384 in the first two years FRANCHISE REQUIREMENTS The franchise had well developed store design standards and specifications, which included that items were sold and how the items were sold. For example, the franchiser prescribed that a specifie Toronto-based A 45 interior design firm draw the store plans according to standards. Also, all retail merchandise and ice cream product had to be sourced through the franchiser, and the ice cream had to be served in a certain way, including weighing each cone before it was served. James considered Gable very open-minded about any suggestion and always willing to negotiate in good faith. The restrictions were meant as quality control on James was assured that the franchiser would be very supportive throughout the siart-up process. Besides supplying James with market information, the franchiser would also equip him with manuals and systems that proved to be effective at the other locations, plus source equipment and fixtures for the store. Also, a team from P.E.I would help set up the store, train the staff and solve any initial problems. The franchise fee was $60,000 due upon signing the agreement. James knew that this fee, an asset, could be amortized on a straight-line basis over 10 years. The agreement also stipulated a royalty of eight per cent of sales, as well as a requirement that the Udderlies spend at least two per cent of sales on local advertising FINANCING The Udderlies used their first meeting with Paul MacNeil, an account manager with the Confederation Bank, to build support for the Lily's concept. They presented MacNeil with the preliminary market research, their revenue projections, photos of the store in PE.L, and a mail-order catalogue. MacNeil was generally opti- mistic about both the idea and his ability to work with the Udderlies. MacNeil was also cognizant that the Confederation Bank had yet to build a strong customer base in the London area and was looking to secure more clients to establish a better presence. At the second meeting, the Udderlies informed MacNeil that they had received a verbal offer from the franchiser to negotiate a deal. In addition, they had chosen a site for the store and had begun negotiating a lense with the owner. The chosen location was on Richmond Row, on the corner of Richmond Street and Central Avenue, across from Victoria Park. Richmond Row contained a number of unique upscale retail stores just north of the downtown area. Victoria Park featured a number of free concerts in the summer and a popular outdoor skating rink open to the public in the winter. James expressed his concern that timing was critical since the whole deal was contingent on the financing, and he would soon be receiving written offers from both his prospective landlord and the franchiser. At this second meeting. James also provided MacNeil with costs estimates. Start-up costs would include $160,000 for equipment and leasehold improvements which would be depreciated on a straight line basis over 10 years. Opening inventory, including ice cream, would be $100,000 and all payables were due to the franchiser on a net 30-day basis. James estimated average inventory, for the next two years, to be about the same amount. Other start-up costs, such as training and other administrative costs, would total $25,000 and could be expensed in the first year. Projected variable costs were 54 per cent of sales for ice cream and 68 per cent of retail sales and included labour. Operating costs, including the manager's salary and rent, would be 57,000 per month and the Udderlies would receive a management fee of $500 per month. Operating costs would likely increase with inflation, which was estimated to be three per cent, but Cow's prices would not. The tax rate was projected to be 23 per cent. James anticipated maintaining a minimum cash balance of approximately $5,000. MacNeil outlined his initial thoughts to the Udderlies. The Udderlies would have to provide a significant amount of collateral and he would need to include several loan covenants in any agreement. However, the Udderlies would likely qualify for a federal program which encouraged small business start-ups while limiting down-side risk. Specifically, the Canadian Federal Government made loans to start up small businesses, under the Small Business Loans Act, as part of its mandate to encourage entrepreneurs to develop enterprises. The Ontario Provincial Government had a new ventures loan program which tended to offer smaller amounts of funding. According to MacNeil, the advantages of using these programs were that there would be fewer collateral and covenant requirements, and the interest rate on these loans was typically in the prime plus 1.75 per cent range. Currently, the prime rate, the rate at which the Bank's best customers could borrow, was seven per cent. Principal re-payment would take 10 years, with one-tenth of the original loan paid off each year starting at the end of the first year. MacNeil could manage the whole loan process for the 46 Part 1 An Assessment of the Firm and its Cash Needs Udderlies, including any tern facility secured from the two levels of government, and any operating line of credit received from the Confederation Bank. The Udderlies felt that, given their life-cycle stage, they could invest all of their liquid assets, about $150,000, but had to limit the collateral. Given the various start-up costs and initial inventory requirements, the Udderlies estimated the need for S160,000 in term loan financing, as well as an operating loan to meet seasonal and other short-term needs. It was anticipated that peak seasonal financing needs would occur between January and March ECONOMIC OUTLOOK The province of Quebec was scheduled to have a general election in the fall of 1994. The Parti Qubcois, a political party whose platform centered on Quebec's secession from Canada, was ahead in the popularity polls. This, along with the fact that Canada had the highest per capita debt levels among the major industri alized countries, had made foreigners leery of investing in Canada. The result was a Canadian dollar that was experiencing increased volatility relative to other currencies and that required intervention by the Bank of Canada to protect its value by increasing short-term interest rates. The effect on the bond market was a noticeable widening of the Canada-US interest rates spread to about 1.50 per cent from 1.15 per cent in April 1994 Canadian cconomic indicators were showing increasing strength on the domestic front as retail sales were up 1.3 per cent in both February and March of 1994 over the previous month. These results were partly off- set by a weaker trade performance. Nevertheless, real gross domestic product (GDP) increased by 0.5 per cent in March and by three per cent in the first quarter of 1994 over the same period a year previously. The inflation environment remained very good with the annual consumer price index (CPT) increasing only by 0.2 per cent and wage settlements averaging up0.5 per cent during the first three months of the year over the same period a year earlier. DECISION The Udderlies were passionate about the franchising idea. They both loved ice cream and found to be unique and exciting. They considered the consequence irLturned out to be simply a fad. The costs that the Udderlies would incur to start up the store were significant, and the store would need to generate income over a number of years to guarantee that the loans were covered. They were confident that was not simply a fad since the ice cream was of very good quality and the retail line was a social satire and was, there fore, perpetually renewable. The Udderlies knew that the ice cream might be moderately cyclical and was certainly seasonal, despite the franchiser's active development of products aimed at smoothing revenue Now, and wondered how that would affect their ability to repay any loans. In order to prepare for his next meeting with MacNeil, James needed to calculate their cash needs and sat down to develop proforma financial statements. 47 Exhibit 1 SELECTED MARKET RESEARCH 1993 Ave. Annual Growth Rate Population Per Capita Income Per Capita Retail Sales 60,200 71,200 95,600 387,300 Huron County Porth County Oxford County Middlesex County (includes London) Eigin County Lambton County 1.03% 0.95% 1.62% 2.21% $ 14,600 16,100 16,400 19,000 $5,200 5,700 5,800 6,700 5,600 6,500 77,300 130,400 1.36% 0.65% 15,700 18,200 Number of Individuals in the Labour Force, Ontario, 1991. Number of Individuals in the Labour Force, London, 1991 Families in Private Households, Total, London, 1993.. Total Supermarkets and Grocery Retail Sales, Canada, 1993. Tourism Expenditure on Food and Beverage, London, 1989. Estimated Number of Tourists, London, 1993.... 5,511,235 169,245 102,935 ..$14.4 billion .$59.4 million .300,000 Sources: The London Visitors and Convention Bureau, The Financial Post, Statistics Canada 48 Part 1 An Assessment of the Firm and its Cash Needs Exhibit 2 ESTIMATED SEASONALITY AND AWARENESS FACTORS AND FORECASTED MONTHLY SALES Seasonality 0.70 0.85 0.95 Month April 1995 May June July August September October November December January 1996 February March 1.00 1.00 0.60 0.50 0.30 0.30 Awareness 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.8 0.8 0.8 0.8 Sales $ 9,266 21,146 34,808 48,470 60,350 43,718 42,530 29,462 29,462 24,710 24,710 34,214 0.25 0.25 0.35 $ 402,850 Total (fiscal year 1995-96) 0.8 0.8 0.8 April 1996 May 0.8 June 0.70 0.85 0.95 1.00 1.00 0.60 0.50 July 0.8 0.8 67,478 81,734 91,238 95,990 95,990 57,974 48,470 29,462 29,462 24,710 24.710 34,214 0.8 0.30 August September October November December January 1997 February March 0.30 0.25 0.8 0.8 0.8 0.8 0.8 0.25 0.35 $ 681,436 Total (fiscal year 1996-97) In September 1994, James and Serena Udderlie were preparing a loan application to a London, Ontario branch of the Confederation Bank of Canada. The Udderlies were requesting a $160,000 term loan, in addition to an operating loan, for the potential opening of a CL ice cream and clothing franchise in London. The Udderlics had a considerable amount of marketing research and cost estimates, and in order to complete the application, they needed to develop proforma income statements and balance sheets for the store's first two years of operation. They also planned to review carefully the qualitative characteris- tics of their idea in order to assess the chances of success of a franchise in London. The Udderlies also wondered what collateral, if any, they would be able to provide the bank to secure against a loan, and what other terms the bank might deem necessary. CL's HISTORY OF GL CL began in 1983 on Prince Edward Island (P.E.I.), Canada, as a single outlet producing and selling ice cream made from a time-honoured family recipe. However, the clothing with whimsical imagery that the staff wore as uniforms began attracting attention and the company soon expanded to include a retail line, which was 75 to 80 items deep by 1995. The retail line, which included such items as t-shirts, sweatshirts, pins and mooing cookie jars, was subsequently offered by mail order in 1991.C25 began **** under the supervision of Professor Steve Foerster sofely to pro need to illustrate either effective or inet mas and 43 fraichising with the opening of a store in Vancouver, British Columbia in 1993, and later opened stores in Park City, Utah and Whistler, British Columbia. Le sold only premium ice cream, with ingredients that included dairy fresh cream, sugar, fresh eggs and pure vanilla. Also, the ice cream included very little of the air found in most commercial ice creams to increase volume. All ice cream was served in a fresh waffle cone made at the ice cream counter in full view of the customers. When customers ordered their cone, they often selected from colourful names such as Customers were treated to a complete experience at CL. The staff were very friendly and were will ing to give customers a sample before they decided on an ice cream flavour. All stores were innovatively dec- crated to include clocks displaying both the local and P.E.I. time, as well as an ice cream menu shaped as a cow with a swinging tongue. But most important to the experience were the clothing items with witty satir- ical designs and captions COLS founder, Cobie Gable, still managed the company in July 1994. The company's creative director, Marc Gallant, a well-known P.E.I. artist, had recently passed away. While Gable was responsible for most of the business decisions that had brought Liis success, Gallant was the creative person behind the art work on the whimsical clothing. Gallant's creativity, inspired by his fascination with cows, was preserved by say ing many of his preliminary designs in - manner that could easily be manipulated by his creative team to develop new designs. JAMES AND SERENA UDDERLIE James Udderlic was the Director of Market Development in the Employee Benefits Division of the Provincial Life Insurance Company. He completed his MBA from the Western Business School in 1983 and joined Provincial in the same year. Although successful and happy in his current position, as James noted, "being an entrepreneur is in the back of the mind of most business school graduates." Serena Udderlie was a spe- cial education teacher who was currently volunteering one day a week while managing their three children full-time, including the youngest child who had not yet entered public school. Serena planned on returning to work full-time once their youngest child was in school. She received a Bachelor of Arts, Bachelor of Education and a Master of Education from the University of Western Ontario, and was the gold medalist while earning the Master's degree. Serena, like her husband, was excited to open up a family business. The Udderlies required that any business they started would neither affect James' commitment to Provincial Life nor their commitment to their family. While James and Serena accepted that changes would be necessary to the family routine, they did not want their children to suffer because of the business and discussed it with them before making a final decision. The Udderlies were under no illusions about the commitment they would have to make to the venture, but they anticipated that if they were to hire a full-time person to manage their investment," then the time requirement could be kept to a manageable level. They felt that their requirements could be met in London since the three locations, the tentative location of the store, Provincial Life and horne, would only be a short distance from cach other. James and Serena planned to incorporate, with each owning 50 per cent of the business. James would be responsible for strategic planning, finance and general management. Serena would take care of hiring the staff and marketing. They would both take turns meeting with their manager on a weekly basis to keep tabs on their investment," by reviewing results, setting store policy and planning promotions THE IDEA The idea for the 's franchise came about when the Udderlie family was camping on PE.1. in the summer of 1992. At that time, James saw a magazine advertisement for Clice cream that caught his attention. What struck James was the "wholesomeness of the layout that depicled a young boy wearing clothing with the distinctive motif and having fun cating ice cream. Later, their neighbours at the campsite said they enjoyed the store they visited, and after the Udderlies visited the store themselves, they were greatly impressed with Their Cow's experience. In particular, they noticed the interesting clothing and its displays, 44 Part 1 An Assessment of the Firm and its Cash Needs the store's layout, the friendliness of the staff and most importantly, the delicious ice cream. After the Udderlies inquired about franchising, a company representative told them that the first company franchise was to open later that summer in Vancouver, British Columbia and that no other franchises were being con sidered. The representative advised the Udderlies that if they were to write a letter outlining the desire to own a franchise, the company would get back to them. The Udderlies had a strong conviction that theCL concept would work in London. The first decision the Udderlies had to make was whether or not to invest time examining the feasibility of a franchise before taking the idea to a financial institution for possible financing. It was not until the summer of 1994 that the Udderlies decided to write to representatives, at which time they received avourable response inviting them to visit the company in PE.L. James traveled alome to PE.L. in July 1994 and spent three days meeting with the franchiser and learning more about the company. During this time, it became obvious to James that while I was a profitable business, a franchise had to want more than just profit from owning a store. The company's core values included a strong persuasion for quality and creativ- ity that made owning a store an expensive proposition. It was believed that only by following these valors would store have all the elements necessary for it to be successful. MARKET RESEARCH James brought with him to PEI. some preliminary market research that he had gathered from Statistics Canada, the Conference Board of Canada and the Convention Bureau of London. He felt that it was in this area that his MBA helped him most he knew how to differentiate the important information from the intelevant as well as how to deal with incomplete market information. From the research, he gathered two key pieces of information: gregate spending on take-out food in the London area and an estimate of the amber of visitors to London. The information in Exhibit I was meant to give James a sense of how many potential customers existed and the extent of their buying power. He focused on the counties around London James figured that his target segment would include tourists, local employed families and local non married, employed individuals over the age of 16. He believed that employment was an important characteristic of his target segment since the price point would be greater than the average price in the industry The population of London in 1994 was approximately 300,000. Using Information he received from the franchises, James figured that local monthly visits would be the product of both the specific month and the degree of local awareness of the store. For example, in the store's first month of operation, targeted for April 1995, he predicted that the seasonality factor would be 70 per cent versus a high of 100 percent in July and the awareness factor 10 percent, verres a high of 80 per cent by November. Since the product of these was seven percent, le figured that seven per cent of 300,000, or 21,000 people would be included in the predisposed base for the month of April. He then predicted that of the base one in twenty would visit the store. Hence, in the month of April, 1,050 individuals from the local population would visit In addi tion, James estimated that 120 tourists would visit the store each month. The predicted seasonality factor, the awareness factor and projected monthly sales are listed in Exhibit 2. The franchise also provided the Udderlies with frequency of purchase date, broken down by product, based on the experience in PEL and Vancouver. Only 10 per cent of all individuals that entered the store left without making any purchase of the remaining 90 per cent, 65 per cent purchased only ice cream, 10 per con purchased only a retail product, and 25 per cent purchased both James estimated that the average expen- ditures per customer would be two dollars for ice cream and $20 for retail. Using this methodology James estimated year one (April 1, 1995 to March 31, 1996) and year two (April 1, 1996 to March 31, 1997) retail sales to be $320,450 and 542,052, respectively, Ice cream sales were projected to be $82,400 and $139,384 in the first two years FRANCHISE REQUIREMENTS The franchise had well developed store design standards and specifications, which included that items were sold and how the items were sold. For example, the franchiser prescribed that a specifie Toronto-based A 45 interior design firm draw the store plans according to standards. Also, all retail merchandise and ice cream product had to be sourced through the franchiser, and the ice cream had to be served in a certain way, including weighing each cone before it was served. James considered Gable very open-minded about any suggestion and always willing to negotiate in good faith. The restrictions were meant as quality control on James was assured that the franchiser would be very supportive throughout the siart-up process. Besides supplying James with market information, the franchiser would also equip him with manuals and systems that proved to be effective at the other locations, plus source equipment and fixtures for the store. Also, a team from P.E.I would help set up the store, train the staff and solve any initial problems. The franchise fee was $60,000 due upon signing the agreement. James knew that this fee, an asset, could be amortized on a straight-line basis over 10 years. The agreement also stipulated a royalty of eight per cent of sales, as well as a requirement that the Udderlies spend at least two per cent of sales on local advertising FINANCING The Udderlies used their first meeting with Paul MacNeil, an account manager with the Confederation Bank, to build support for the Lily's concept. They presented MacNeil with the preliminary market research, their revenue projections, photos of the store in PE.L, and a mail-order catalogue. MacNeil was generally opti- mistic about both the idea and his ability to work with the Udderlies. MacNeil was also cognizant that the Confederation Bank had yet to build a strong customer base in the London area and was looking to secure more clients to establish a better presence. At the second meeting, the Udderlies informed MacNeil that they had received a verbal offer from the franchiser to negotiate a deal. In addition, they had chosen a site for the store and had begun negotiating a lense with the owner. The chosen location was on Richmond Row, on the corner of Richmond Street and Central Avenue, across from Victoria Park. Richmond Row contained a number of unique upscale retail stores just north of the downtown area. Victoria Park featured a number of free concerts in the summer and a popular outdoor skating rink open to the public in the winter. James expressed his concern that timing was critical since the whole deal was contingent on the financing, and he would soon be receiving written offers from both his prospective landlord and the franchiser. At this second meeting. James also provided MacNeil with costs estimates. Start-up costs would include $160,000 for equipment and leasehold improvements which would be depreciated on a straight line basis over 10 years. Opening inventory, including ice cream, would be $100,000 and all payables were due to the franchiser on a net 30-day basis. James estimated average inventory, for the next two years, to be about the same amount. Other start-up costs, such as training and other administrative costs, would total $25,000 and could be expensed in the first year. Projected variable costs were 54 per cent of sales for ice cream and 68 per cent of retail sales and included labour. Operating costs, including the manager's salary and rent, would be 57,000 per month and the Udderlies would receive a management fee of $500 per month. Operating costs would likely increase with inflation, which was estimated to be three per cent, but Cow's prices would not. The tax rate was projected to be 23 per cent. James anticipated maintaining a minimum cash balance of approximately $5,000. MacNeil outlined his initial thoughts to the Udderlies. The Udderlies would have to provide a significant amount of collateral and he would need to include several loan covenants in any agreement. However, the Udderlies would likely qualify for a federal program which encouraged small business start-ups while limiting down-side risk. Specifically, the Canadian Federal Government made loans to start up small businesses, under the Small Business Loans Act, as part of its mandate to encourage entrepreneurs to develop enterprises. The Ontario Provincial Government had a new ventures loan program which tended to offer smaller amounts of funding. According to MacNeil, the advantages of using these programs were that there would be fewer collateral and covenant requirements, and the interest rate on these loans was typically in the prime plus 1.75 per cent range. Currently, the prime rate, the rate at which the Bank's best customers could borrow, was seven per cent. Principal re-payment would take 10 years, with one-tenth of the original loan paid off each year starting at the end of the first year. MacNeil could manage the whole loan process for the 46 Part 1 An Assessment of the Firm and its Cash Needs Udderlies, including any tern facility secured from the two levels of government, and any operating line of credit received from the Confederation Bank. The Udderlies felt that, given their life-cycle stage, they could invest all of their liquid assets, about $150,000, but had to limit the collateral. Given the various start-up costs and initial inventory requirements, the Udderlies estimated the need for S160,000 in term loan financing, as well as an operating loan to meet seasonal and other short-term needs. It was anticipated that peak seasonal financing needs would occur between January and March ECONOMIC OUTLOOK The province of Quebec was scheduled to have a general election in the fall of 1994. The Parti Qubcois, a political party whose platform centered on Quebec's secession from Canada, was ahead in the popularity polls. This, along with the fact that Canada had the highest per capita debt levels among the major industri alized countries, had made foreigners leery of investing in Canada. The result was a Canadian dollar that was experiencing increased volatility relative to other currencies and that required intervention by the Bank of Canada to protect its value by increasing short-term interest rates. The effect on the bond market was a noticeable widening of the Canada-US interest rates spread to about 1.50 per cent from 1.15 per cent in April 1994 Canadian cconomic indicators were showing increasing strength on the domestic front as retail sales were up 1.3 per cent in both February and March of 1994 over the previous month. These results were partly off- set by a weaker trade performance. Nevertheless, real gross domestic product (GDP) increased by 0.5 per cent in March and by three per cent in the first quarter of 1994 over the same period a year previously. The inflation environment remained very good with the annual consumer price index (CPT) increasing only by 0.2 per cent and wage settlements averaging up0.5 per cent during the first three months of the year over the same period a year earlier. DECISION The Udderlies were passionate about the franchising idea. They both loved ice cream and found to be unique and exciting. They considered the consequence irLturned out to be simply a fad. The costs that the Udderlies would incur to start up the store were significant, and the store would need to generate income over a number of years to guarantee that the loans were covered. They were confident that was not simply a fad since the ice cream was of very good quality and the retail line was a social satire and was, there fore, perpetually renewable. The Udderlies knew that the ice cream might be moderately cyclical and was certainly seasonal, despite the franchiser's active development of products aimed at smoothing revenue Now, and wondered how that would affect their ability to repay any loans. In order to prepare for his next meeting with MacNeil, James needed to calculate their cash needs and sat down to develop proforma financial statements