Background:  It is important to be able to understand and build financial statements.  These skills are essential to effective business planning.  This assignment is designed to help cultivate these skills.  The first part aims to enhance understanding of financial statements by building ratio analysis and interpretation abilities.  The second part seeks to grow statement construction and forecasting abilities by asking you to use the information provided to create financial statements.

Instructions:

Part A (25 marks)

Please find attached a multi-year Income Statement (Appendix A1) and multi-year Balance Sheet (Appendix A2) for Canadian Motorbikes.  This company is a (fictional) motorcycle manufacturer that brought on a new CEO in 2012.  You work for an investment company that is considering investing in the motorcycle company – and, if the investment is made, whether or not to retain the CEO.  You are part of a team that is evaluating the performance of the company.  Your job is to calculate and interpret important financial ratios and to make comments to help make a decision on whether or not to invest.   Appendix A3 contains financial ratio averages for all companies in the industry.  This should be useful.

Please use the information in Appendix A1 to A3 to do the following:

1. Calculate the Current Ratio, Debt Ratio, Return on Assets (ROA) and Return on Equity (ROE). For the ROA and ROE, you should use the average total assets and the average total equity in your calculations.  (The average is the total across two years divided by two).  Calculate these values for each of 2011-2014.  Interpret your calculations: what does this information mean?  How is the company doing?  (16 marks)

2. Calculate ratios related to how quickly the company pays its trade debt and how quickly it collects from its customers. These are known as Accounts Payable (AP) Turnover and Accounts Receivable (AR) Turnover.  The formula for AP Turnover is:  Cost of Goods Sold/average accounts payable. The formula for AR Turnover is: credit sales/average accounts receivable.   Calculate the AP and AR Turnover for each of 2011-2014.  Interpret your calculations: what does this information mean?  How is the company doing?  (9 marks)

Part B (75 marks)

1. It is January 1^st, 2014 and Oscar D’Souza has decided to start a new business. He wants to forecast the first year’s Income Statement and Balance sheet.  He believes the assumptions below are reasonable – and wants you to assist him by creating the forecasted statements.  You agree.  Please construct an Income Statement and Balance Sheet from the information provided below. (25 points)

1. First year sales will total $100,000
2. Gross margins will be 50%
3. Operating margins will be 20%
4. Accounts Receivables will be about 15% of sales
5. Inventory will be 12% of sales
6. Accounts Payable will be 5% of sales
7. Accrued expenses payable will be 7% of sales
8. The Bank of Connecticut will provide a loan of $30,000. The annual interest will be 8%, compounded annually.  Interest only payments are needed – until the loan is due in 5 years, where a balloon payment for the full balance must be paid.
9. The combined federal and provincial tax rates will be 30%
10. Capital equipment purchases will be made at the start of the year. These will total $35,000.  These will depreciate at 10% per year
11. D’Souza wants ending cash to be $24,500; he feels he needs this on hand at year-end
12. D’Souza will provide any other capital needed in the form of equity financing

2. It is January 1^st, 2015. 2014 turned out very well for Oscar – his projections were quite close. He wants you to project out an Income Statement, Balance Sheet and a Cash Flow Statement for 2015 using the new assumptions outlined below. (40 points)

1. 2015 year sales will each be 25% higher than the $110,000 realized in 2014
2. Gross margins in 2015 will be 55, 5% higher than the 50% realized in 2014
3. Operating margins will be 22%, 2% higher than 20% realized in 2014
4. Accounts Receivables will be 12% of sales, lower than the 15% seen in 2014
5. Inventory will be 15% of sales, higher than the 12% seen in 2014
6. Accounts Payable will be 4% of sales in 2015, lower than the 5% seen in 2014
7. Accrued expenses payable will be 4% of sales in 2015, lower than the 7% seen in 2014
8. The Bank of Connecticut will continue to be paid 8% interest on the $30,000 worth of loans.
9. The combined federal and provincial tax rates will be 30%
10. No new capital purchases are made
11. Closing cash is expected to remain at the same level predicted for and seen in 2014
12. Depreciation of existing capital equipment continues at the same rate observed in 2014

3. Comment on the performance of Bart D’Souza’s company. How is the company doing? He is working at this business part-time.  Should he quit his other job and work at this full-time?  Should he do the opposite – and exit the business?  Or, should he stay the course and see how things unfold?  What other kinds of information might you want to know to answer these questions? (10 marks)