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 $1-million long-term loan in order to finance further expansion plans. Specifically, the funds would be used to purchase additional capital assets. SWLs 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 preliminary 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 SWLs file. Maria: SWL has provided us with a copy of their most recent statement of financial position and income 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, thats 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 havent 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 information 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 banks database for industry comparables. Peter has located various industry ratios that can be used as a benchmark (Exhibit III). Required Assume the role of Peter and prepare the report. 6 Sky Watchers Ltd. 29 Sky Watchers Ltd. Statement of Financial Position As at December 31 2020 2019 Assets Current Cash $ 35,359 $ 134,550 Marketable securities 145,780 457,206 Accounts receivable 223,450 174,930 Inventory 425,770 355,790 Prepaid expenses 17,500 19,500 847,859 1,141,976 Property, plant, and equipment, net 2,956,950 2,492,655 3,804,809 3,634,631 Liabilities and shareholders equity Current Accounts payable 294,305 95,700 Accrued and other liabilities 237,595 244,760 Current portion of long-term debt 375,900 345,900 907,800 686,360 Long-term debt 1,280,330 1,601,500 Common shares (50,000 outstanding) 595,817 595,817 Retained earnings 1,020,862 750,953 1,616,679 1,346,771 $3,804,809 $3,634,631 Exhibit I Financial Statements 7 FINANCIAL STATEMENT 30 PREPARATION AND ANALYSIS Exhibit I Financial Statements (Continued) Sky Watchers Ltd. Income Statement For the year ended December 31 2020 2019 Sales $2,975,990 $2,575,990 Cost of sales 1,368,955 1,184,955 Gross profit 1,607,035 1,391,035 Expenses Amortization 155,490 125,490 General and administrative 134,500 102,800 Marketing and sales 175,680 155,600 Interest expense 76,820 96,090 Office expense 295,980 255,000 Wages and benefits, administration 315,000 315,000 Total operating expenses 1,153,470 1,049,980 Operating income 453,565 341,055 Gain (losses) on marketable securities 25,475 9,800 Impairment loss on capital assets 0 0 Income (loss) before taxes 479,040 350,855 Provision for (benefit from) income taxes 134,131 98,239 Net income 344,909 252,615 Opening balanceretained earnings 750,953 573,338 Net income 344,909 252,615 Dividends 75,000 75,000 Closing balanceretained earnings $1,020,862 $ 750,953 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 II Information About the Use of the Loan 8 Sky Watchers Ltd. 31 Ratio Industry Average Profitability 2020 1 Return on equity 15.0% 2 Return on assets 8.0% 3 Financial leverage percentage 7.0% 4 Earnings per share $ 4.40 5 Quality of income 75.0% 6 Profit margin 10.0% 7 Fixed asset turnover 2.00 Tests of liquidity 8 Cash ratio 7.0% 9 Current ratio 1.00 10 Quick ratio 0.75 11 Receivable turnover 13.00 12 Average days in accounts receivable 28.08 13 Payable turnover 19.00 14 Average days in accounts payable 19.21 15 Inventory turnover 6.50 16 Average days in inventory 56.15 Solvency and equity position 17 Times interest earned 5.40 18 Cash coverage 6.30 19 Debt to equity ratio 1.35 Miscellaneous 20 Book value per share $29.00 Exhibit III Industry Benchmark Ratios 9

For the first part of this work assignment assume that Maria has requested that you follow up next week with a report specifically addressing her immediate concerns as follows:

1. Marias concern over the significant decline in the cash position of SWL from 2019 to 2020. Specifically determine where the companys source of cash is generated from and where it has been used/employed. Make a conclusion on the companys use of cash in the past year.
2. Determine what the financial statements would look like if the loan were to go through.
3. Determine if SWL will have enough cash to pay both the loan and the interest.