Sky Watchers Ltd. Sky Watchers Ltd. (SWL) is a manufacturer of telescopes and binoculars, offering products to amateurs and professionals. The company has experienced significant growth in the past five years due to an increase in the popularity of star gazing, combined with an effective branding campaign and enhanced distribution network. The company has applied to the Bank of Winnipeg for a Sl-million long-term loan in order to finance further expansion plans. Specifically, the funds would be used to purchase additional capital assets. SWL's application and financial statements have been provided to Peter Sparks, a newly hired junior analyst with the Bank of Winnipeg. Peter has been asked by his supervisor, Maria Simms, to conduct a pre- liminary review of SWLs financial statements and determine whether SWL should proceed further into a more detailed analysis. Maria has asked Peter to document his recommendation and supporting analysis in a report that will be maintained in SWE's file. Maria: "SWL has provided us with a copy of their most recent statement of financial position and in- come statement (Exhibit I). I know that this may not be enough to make the final decision, but it should be more than enough for you to get started." Peter: "Yes, I can obtain much information from these two statements." Maria: "Okay, that's great. I took a quick look at the statement of financial position and am wondering what has caused the change in cash. Cash is needed to pay back the loan. Although I haven't done any rigorous analysis, it is a bit concerning to see the cash decline by such a large amount Peter: "I can definitely look into the decrease in cash." Maria: "It may also be useful to give some thought to what the statement of financial position may look like if the loan is approved. Historical statements are fine, but they will not be able to provide you with this information. Additional information on the use of the loan is provided in Exhibit II." Peter: "That is a great point. I will take this into consideration." Maria: "Alright. Let me know if I can be of any further assistance. I look forward to reading your report If you recommend to proceed with future due diligence, can you prepare a list of additional infor mation that would be useful in making our final decision?" PORR WOLIUCTTI ge in cash. Cash is needed to pay back the loan. Although I haven't done any rigorous analysis, it is a bit concerning to see the cash decline by such a large amount." Peter: "I can definitely look into the decrease in cash." Maria: "It may also be useful to give some thought to what the statement of financial position may look like if the loan is approved. Historical statements are fine, but they will not be able to provide you with this information. Additional information on the use of the loan is provided in Exhibit 11." Peter: "That is a great point. I will take this into consideration." Maria: "Alright. Let me know if I can be of any further assistance. I look forward to reading your report. If you recommend to proceed with future due diligence, can you prepare a list of additional infor- mation that would be useful in making our final decision?" Peter: "Yes, I can most certainly do that. I will get started right away." Peter is excited about his first assignment, and wants to impress Maria. Peter begins to conduct some preliminary research by searching the bank's database for industry comparables. Peter has located various industry ratios that can be used as a benchmark (Exhibit III). Required ACC1304 - INDIVIDUAL ASSIGNMENT 2 Assume the role of Peter and prepare the report. 1. Analyze the financial statements and explain the decrease in cash. 2. Prepare pro forma financial statements for 2018, assuming the full impact of the investment occurs in 2018 3. Select 5 ratios from the list of industry benchmark ratios. Justify your choice by explainng how these ratios help you make a decision to approve the loan or not. 4. Calculate these 5 ratios for 2016, 2017 and 2018 and analyze them. 5. Based on your analysis of the financial statements and the ratios: a. Determine whether the loan should be approved or not. Justify your answer b. List a maximum of two issues and specific related questions you would like to ask Sky Watchers Ltd. EXHIBITI - FINANCIAL STATEMENTS SKY WATCHERS LTD. STATEMENT OF FINANCIAL POSITION 2017 As at December 31 2016 Assets Current Cash Marketable securities Accounts receivable Inventory Prepaid expenses $ 35,359 145,780 223.450 425,770 17.500 847,859 $ 134,550 457,206 174.930 355,790 19,500 1,141,976 Property, plant, and equipment, net 2.956,950 3.804,809 2,492,655 3,634,631 Liabilities and shareholders' equity Current Accounts payable Accrued and other liabilities Current portion of long-term debt 294,305 237,595 375,900 907,800 95,700 244.760 345,900 686,360 Long-term debt 1.280,330 1.601.500 Inventory Prepaid expenses 425,770 17,500 847,859 355,790 19,500 1.141,976 Property, plant, and equipment, net 2,956,950 3,804,809 2,492,655 3,634,631 Liabilities and shareholders' equity Current Accounts payable Accrued and other liabilities Current portion of long-term debt 294,305 237,595 375,900 907.800 95,700 244,760 345,900 686,360 Long-term debt 1.280.330 1.601.500 Common shares (50,000 outstanding) Retained earnings 595,817 1,020,862 595,817 750,953 1.346.771 $3,634.631 1.616.679 $3.804,809 EXHIBITI (CONTINUED) - FINANCIAL STATEMENTS SKY WATCHERS LTD. INCOME STATEMENT 2017 2016 For the year ended December 31 Sales Cost of sales Gross profit $2,975,990 1,368,955 1.607,035 $2,575,990 1,184,955 1,391,035 Expenses Amortization General and administrative Marketing and sales Interest expense Office expense Wages and benefits, administration Total operating expenses 155,490 134,500 175,680 76,820 295,980 315.000 1.153.470 125,490 102,800 155,600 96.090 255,000 315,000 1,049,980 341.055 9.800 0 Operating income Gain (losses) on marketable securities Impairment loss on capital assets Income (loss) before taxes Provision for (benefit from) income taxes Net income 453,565 25,475 0 479,040 134,131 344,909 350,855 98.239 252,615 Marketing and sales Interest expense Office expense Wages and benefits, administration Total operating expenses 175,680 76,820 295,980 315,000 1,153,470 155,600 96,090 255,000 315,000 1,049,980 341,055 9,800 Operating income Gain (losses) on marketable securities Impairment loss on capital assets Income (Loss) before taxes Provision for (benefit from) income taxes Net income 0 453,565 25,475 0 479,040 134,131 344,909 350,855 98.239 252,615 Opening balance-retained earnings Net income Dividends Closing balance-retained earnings 750,953 344.909 75.000 $1.020.862 573,338 252,615 75,000 $ 750,953 Section 2: Financial Statement Preparation and Analysis 45 EXHIBIT IL - INFORMATION ABOUT THE USE OF THE LOAN > The loan will be used to purchase $1 million in additional capital assets. The additional assets will result in an increase in revenues of 20%. The loan will bear interest at 6%. Principal payments of $200,000 per annum will be required. The company will withhold any dividend payment during the foreseeable future in order to support the debt to equity ratio. The capital assets are expected to have a useful life of 15 years with no residual value. All other fixed expenses are expected to remain consistent. The existing loan will require a principal payment of approximately $375,900 during the upcoming fiscal year. The payment for the following fiscal year is expected to be $300,000. Accounts receivable, inventory, prepaid expense, and accounts payable will all increase by 40% as a result of the increased sales. The marketable securities will be converted to cash at the beginning of the year. EXHIBIT III - INDUSTRY BENCHMARK RATIOS Industry Average Ratio EXHIBIT III - INDUSTRY BENCHMARK RATIOS Ratio Industry Average 2017 1 2 3 4 15.0% 8.0% 7.0% $4.40 75.0% 10.0% 2.00 S 6 7 8 9 10 11 12 13 14 15 16 Profitability Return on equity Return on assets Financial leverage percentage Earnings per share Quality of income Profit margin Fixed asset turnover Tests of liquidity Cash ratio Current ratio Quick ratio Receivable turnover Average days in accounts receivable Payable turnover Average days in accounts payable Inventory turnover Average days in inventory Solvency and equity position Times interest earned Cash coverage Debt to equity ratio Miscellaneous Book value per share 7.0% 1.00 0.75 13.00 28 08 19.00 19.21 6.50 56.15 17 18 19 5.00 6.10 1.35 20 $29.00