Accounting Quiz

timer Asked: Apr 24th, 2017

Question description


This is 6-7 pages long

A good report is crucial to communicating what you have done and instilling confidence in the reader that you have done a thorough analysis.A report should be well-organized with a definite path that leads the reader from an introduction to a conclusion.Outlining your report in advance could aid you in this endeavor.A typical outline might look something like this:


The purpose of the analysis and report


A brief summary of the company does and how the business is changing.(Outlook for increased sales due to more focused marketing efforts, larger customer accounts, etc.)


  • Projected Income Statements
    • Sales
    • Cost of goods sold
    • Administrative expenses
    • Depreciation expense
    • Interest expense
    • Taxes
  • Projected Balance Sheets
    • Projected asset requirements to support projected sales
      • Cash
      • Accounts Receivable
      • Inventories
      • Fixed Assets
    • Financing of asset requirements
      • Accounts Payable
      • Accruals
      • Long-term Debt
      • Retained Earnings (Dividend policy)
      • Additional Financing Required
  • Statement of Cash Flows (This would show the annual needs versus the cumulative needs indicated on the balance sheets)
  • Financing Alternatives
    • Debt
      • Bank restrictions
      • Total debt availability
      • Short-term debt availability

b.Required equity financing


Advantages and Disadvantages of financing alternatives.What you would recommend and why.

In writing up the report, be as concise as possible.Remember, the person who is reading the report is a busy person and all “fluff” does is waste their time.Also, the report should be written so that a non-technical person can get a basic understanding of what you have done.For example, in describing the projection of accounts receivable, one might write

“Accounts receivables are projected to increase from their current level of $110,800 to $351,435 by 2018 (See Exhibit II).The tripling of receivable balances over this period, when sales are anticipated to only double in volume, is due to more of our customers demanding more advantageous credit terms.The result is an expected increase in the average collection period from approximately 32 days to just over 40 days (See Exhibit IV for calculations).”

You have communicated to the reader what your numerical analysis reveals and why it does so without burdening them with the detail of how it was calculated.Thus, a non-numbers person can understand what is anticipated to occur in terms of increased asset (receivables) requirements and the cause of the increase.A more technically-oriented person (such as myself) has been directed to Exhibit II to see the actual balance sheets and to Exhibit IV in order to see how you have derived the average collection periods using ratios, probabilities, or whatever.

The report itself should only quote key figures from the exhibits such as the beginning and ending accounts receivable balances used in the above example.(Obviously, in some cases, such as the amount of financing needed, you will want to quote the amount required for each year.)The bulk of the numbers should otherwise be restricted to exhibits.Exhibits should be numbered.In general, an exhibit that is not referred to in the report is not needed for the report and should not be included. (There can be exceptions to this, but they are relatively rare.)

The result of a good report is that the reader can understand what you have done without having to look at the exhibits specifically, feel confident in your abilities to analyze the circumstances, and be persuaded into accepting your conclusions.

I strongly encourage you to proofread your report very carefully.While some errors will inevitably be missed, you want to minimize them.The spell-checker and grammar-checker in Word are notoriously bad and cannot tell that the word “in” should have been “is”.Mistakes in your spelling and grammar cast serious doubt upon the quality of the analysis itself.

COLLECTIBLES, INC. Collectibles, Inc., produces a variety of consumer products, including dolls and jewelry. It's primary products are manufactured in China and sold through gift shops throughout the United States as well as via the Television Shopping Network (TSN). The television marketing also involves the use of a well-known celebrity whose name has become associated with the various dolls that she “pitches” on six different days during the year. Prior to 2015, Collectibles (formerly, Knicknacks, Inc.) had concentrated solely on the gift items categories. In late 2014, Knicknacks completed the acquisition of the Bock Company. Bock was a designer and manufacturer of custom jewelry that was sold in a variety of Asian and Middle Eastern countries but had encountered financial difficulties necessitating that it seek protection in bankruptcy court. Knicknacks was able to structure a merger with Bock that resulted in the formation of Collectibles. The merger resulted from a combination of new equity infusion and the restructuring of supplier debt, both in the form of preferred stock that carried a zero percent dividend rate but was payable over a five-year period (an equity “kicker” was included as part of the preferred stock). The proposal was viewed as superior to a competing bid and won approval from the bankruptcy court. The result of the business combination proved to be quite successful as a result of the synergies realized by relocation of the jewelry manufacturing to the Asian continent and the ability to introduce one line of jewelry to the U.S. market through the Television Shopping Network. Collectibles was also beginning to make in-roads into the European market as a result of the distribution channels of the Bock jewelry line. The European market proved to be receptive to the dolls and other collectible product lines of the company and was expected to provide a significant source of sales growth over the next three years. Collectibles currently is in negotiations with Starlight Jewelry Manufacturing, Inc., a company that manufactures and sells low-end jewelry throughout the United States. The appeal of Starlight to Collectibles is two-fold: first, it provides a complement to the higher-priced custom jewelry lines that it currently sells and is expected to allow certain synergies to be realized through consolidation of facilities. The CFO anticipates the consolidations to produce savings of approximately $600,000 per year. Moreover, the resulting surplus productive capacity would be such that no capital expenditures were considered necessary in the foreseeable future. Even then, the use of subcontracted Asian manufacturing facilities was expected to result in the shifting of the burden of equipment purchases to the subcontractors. In addition to the annual consolidation savings, the CFO felt that the Cost of Goods Sold of the combined entity could be reduced by one percent by pressuring suppliers to pass along some of the economies of scale that the larger volume of purchasing would provide. The second incentive for acquiring Starlight was the fact that TSN had been pressuring Collectibles to develop a low-end jewelry line that was more in line with the buying habits of its customers. Although the sales of Collectibles' Bock jewelry line had been favorable, the relatively high price of the custom jewelry line was seen as being quite limiting in the ability of the network to fully develop a customer base for the jewelry. Starlight Jewelry appeared to be a means by which Collectibles could produce a low-cost, low profit margin line that would bolster the Bock brand name on TSN while being affordable to the viewers. The added distribution channel of TSN was, therefore, viewed as a means of significantly expanding the sales of Starlight over the next two-to-three years. The acquisition of Starlight would be through an asset purchase and would necessitate that Collectibles restructure its own financing as well as finance the acquisition. The long-term debt of Collectibles contained a clause that dictated no additional debt (other than a revolving line of credit secured by inventories and receivables) was allowed. The revolving line of credit utilized by Collectibles was from Econova Bank and carried an interest rate of prime plus 4½% (the prime rate is currently 3.25%). The revolver was limited to 70% of accounts receivable plus 18% of inventories based upon the historical breakdown of an aging of accounts receivable and the work-in-process versus finished goods inventories. Econova Bank was also the provider of the current $4½ million of long-term debt of Collectibles and indicated a willingness to refund the current debt as well as providing some of the funding for the acquisition of Starlight Jewelry. The new long-term debt would be at the same rate as the revolving line of credit (currently 7.75%) and payable over a five-year period on a fully amortized basis. The refunding of the long-term debt at a lower interest rate than the current long-term debt was agreed upon in order to reflect the new equity as well as the threat to move the company’s financing to the Eastern Seaboard Bank which had made a competitive offer of financing. The restrictions would be similar to the restrictions on the current debt: 1) no new debt would be allowed except for revolving debt secured by receivables and inventories; 2) the firm must maintain a Quick Ratio of at least 1.25; and 3) the company must maintain a Debt Service Coverage Ratio [EBITDA/(Interest + Principal)] of at least 1.75. Your task: Determine the value that Collectibles should be willing to pay for Starlight Jewelry. Note that Collectibles will not assume any of Starlight's debt (i.e., it is buying the assets of Starlight debt-free). Once a value has been determined, assume that the acquisition will be at the price that you determined and will be paid for through a loan and additional equity from venture capitalists. The venture capitalists like to see 50-60% of the purchase be financed through debt and want a rate of return of 25-30% on their equity investment. Since Collectibles will be acquiring the financing, assume that the terms of the line of credit for Starlight's receivables and inventories will be those of Collectibles. Also, assume that a completely new loan package will have to be structured that will refinance all of Collectible's existing debt in addition to the 5060% acquisition price. The new loan will be payable over five years and have similar restrictions to Collectible's current debt. Finally, write up your analysis as a concise, coherent report. I should be able to read through the report and have a good understanding of what you have done in your analysis. Your projections should be attached as exhibits and referred to in the report as needed. Your ability to clearly communicate what you have done is at least as important as your analysis.
Abigail Medina kyi439 @01307273 VALUATION REPORT ON THE ACQUISITION OF STARLIGHT FY 2014 Determining the value of the target (Starlight) and whether or not the purchase is possible through financing provided in part by Eastern Seaboard Bank. TABLE OF CONTENTS Contents Background/Purpose_____________________________________________________________________________________1 Analysis__________________________________________________________________________________________________2-4 Conclusions/Recommendations_________________________________________________________________________5 Tables/Exhibits _______________________________________________________________________________________6-19 Background/Purpose BACKGROUND Collectibles Inc. is a producer of consumer goods that current makes products such as dolls and jewelry. Their products are produced in China and sold in numerous small shops as well as on the Television Shopping Network (TSN). Although Collectibles is currently operating at a profit, they have recently become interested in acquiring the assets of Starlight Jewelry Manufacturing Inc. (thus resulting in a merger of the two companies). Starlight is a company that currently manufactures and sells low-end jewelry in the United States. Through this merger, both companies would achieve numerous operating efficiencies including reductions in cost of goods sold of 1% and $600,000 in salary savings. In addition to these synergies, Collectibles also expects the acquisition to complement the higher-priced custom jewelry it currently sells (thus appealing to the buying habits of its existing customers) and to eliminate capital expenditures in the foreseeable future. If the merger is approved, the acquisition will be paid for through a loan (accounting for 60% of the acquisition price) and additional equity from venture capitalists (accounting for the remaining 40%). In addition to this, the accounts payable of the target would be assumed. However, in order for the purchase to be viable, Collectibles Inc. (which would now include Starlight Inc.) would have to maintain a Quick Ratio of at least 1.25 and a Debt Service Coverage Ratio of at least 1.75 to satisfy Eastern Seaboard Bank’s loan requirements. PURPOSE The nature of this report is to communicate what the value of the company is calculated to be, whether or not this purchase is feasible, and if it is, what the financing structure would look like. In the analysis section, the assumptions made are presented as well as what financial statements are expected to look like post-acquisition. The report then concludes with a recommendation on whether or not merging with Starlight (i.e. the target) is in Collectibles’ (i.e. the buyer) best financial interest. Page 1 Analysis GENERAL ASSUMPTIONS MADE In determining the value of the target the following basic assumptions were made: • Only the assets of Starlight Inc. will be assumed (excluding cash). • The accounts payable of the target will be assumed. • The purchase will be financed through 60% debt and 40% equity. • Pro forma financial statement numbers will be calculated based on historical data using the percentage of sales approach (e.g. cost of goods sold will be forecasted using the average percent of COGS from 2011 to 2014 over total sales for the year projected), unless otherwise noted below. • If the aforementioned ratios are not met, the merger will not be recommended to Collectibles Inc. PROJECTED INCOME STATEMENTS Through the merger of Collectibles and Starlight Inc., net income after taxes is expected to increase from $6,157,743 to $10,974,207 by 2018 (see Exhibits I-III). This is attributable to operating synergies, as demonstrated by the line item Synergies from Cost Reductions on the income statement. The line item represents $600,000 of annual salary savings and a reduction of 1% in cost of goods sold at the consolidated level. The 78% in net income is also attributable in part to the fact that no more capital expenditures will occur as operating synergies will occur with the combination of both entities fixed assets. As asset lives and historical costs were not provided and net fixed assets are presented at a negative balance in Starlight’s historical financial statements, depreciation is set at $0 for subsequent years for both firms in order to depict a more accurate balance in net fixed assets. A similar situation arose for amortization expense. Other administrative expenses were calculated based on the percentage sales approach as outlined in greater detail in the section above. However, if expenses had remained constant for two or more years, the value was carried forward as the projected value (except when dealing with taxes). Commissions & Royalties/Fees were also zeroed out for Starlight as we determined this line item could be eliminated due to the consolidation. In other words, commission's costs will be reduced due to a reduction in workforce (specifically relating to the sales department). Interest expense was also zeroed at the firm level as the target’s debt was not to be assumed. However, in the consolidated income statement is based on a 7.75% rate applied to both the new long-term debt and the revolving line of credit (explained in more detail in the Conclusions/Recommendations section). Page 2 Taxes were calculated based on a corporate tax rate of 40%. As information regarding carryforwards was not provided, it was disregarded. PROJECTED BALANCE SHEETS Assets were determined on varying bases on the balance sheet and were projected to increase from $33,355,212 to $55,436,953 by 2018. Cash was zeroed out for Starlight Inc. as it was expected to be paid out as a dividend to existing shareholders. In the consolidated statements, cash was set as the necessary amount needed to support projected sales after other assets were projected (see Exhibits IV-VI). The balances in accounts receivable were projected based on the historical average collection period of 43 days for Collections and 58 days for Starlight (see Table 1) based on total sales. A similar approach was taken in calculating the inventory levels for both firms. The values were based on inventory turnover ratios of 6.54 for Collectibles and 2.37 for Starlight Inc. (see Table 2) and them summed at the consolidated level. As the consolidated firm becomes more stable, we anticipate the average collection period to drop and the turnover ratio to increase by year 2020. As no further capital expenditures will be required and we stopped depreciating fixed assets due to previous accounting errors, net fixed asset balance are expected to remain constant in the foreseeable future. Accounts payable are once more calculated based on the percentage of sales method. Since they are to be assumed by the buyer they are included in the consolidated balance sheet. Unlike accounts payable, Accrued Expenses on the consolidated balance sheet includes only the buyer’s portion of the expenses as this liability will not be assumed. Accrued Income/Other Tax include both firms and have been maintained constant as these figures are not expected to fluctuate. Due to the merger, financing will be restructured using 60% debt (consisting of both long-term debt and a revolving credit line) and 40% equity; see the Financing Alternatives section for a breakdown of the financing structure and the balances. Once again, the balances of liabilities and stockholder’s equity reflect the buyer’s prior balances as well as the amounts necessary to finance the asset requirements of the firm as a whole. For the first few years, the consolidated firm will not be paying out dividends. This is because management plans on building up the equity before dividends begin being paid out (beginning in year 2020 if the firm’s position remains favorable). Due to this, retained earnings will increase exponentially from $3,831,954 to $40,238,853 by 2018. Page 3 STATEMENT OF CASH FLOWS The statement of cash flows indicated that virtually all cash inflows stem from operations; more specifically from net income and a reduction in current liabilities for years 2014 through 2018 (see Exhibits VII-IX). There are no investing activities that occur for any of the years, but the balances in the financing section are primarily due to repayment of long-term debt and preferred stock. Due to these activities, and the lack of dividend payouts, the cash balance increases significantly from $2,721,329 to $16,135,654. FINANCING ALTERNATIVES Our analysts have determined the Net Present Value of the target to be $7,849,026 with a weighted average cost of capital of 14.79% based on the table below: Operating Cash Flow Cash Flow from Investing Terminal Value Total Cash Flow NPV @ 14.79% = ($409,041) $0 $536,152 $0 $689,820 $0 ($409,041) $536,152 $689,820 $1,087,260 $0 $11,661,116 $12,748,376 $7,849,026 As has been mentioned throughout the report, the merger is to be financed with 60% debt and 40% equity (provided by venture capitalists). In regards to the debt financing portion it is our recommendation that 75% be financed via long-term debt ($6,140,880) to be paid over a 5 year period and that the remaining 25% ($2,046,960) be financed using the revolving line of credit extended by Eastern Seaboard Bank (both having a 7.75% interest rate); see the table below for a breakdown. Financing: Sources: A/P Debt for Acq New Equity Total Sources = 1,702,226 4,709,415 3,139,610 9,551,252 Uses: Assets Goodwill 8,512,695 Net of Cash 1,038,557 Total Uses = 9,551,252 LOC LT Debt 2,046,960 6,140,880 New Debt Package Debt for Acq Existing Revolver Existing LTD Total Debt Package 4,709,415 0 3,478,424 8,187,839 Year Payment 2014 2015 2016 2017 2018 2019 Page 4 1,527,902 1,527,902 1,527,902 1,527,902 1,527,902 25% 75% Interest 475,918 394,389 306,542 211,887 109,896 Principal 1,051,984 1,133,513 1,221,360 1,316,016 1,418,007 Balance 6,140,880 5,088,895 3,955,383 2,734,022 1,418,007 0 Conclusions/Recommendations Based on the analysis provided in previous sections and the valuation of Starlight Inc., it is our recommendation that the merger of the two firms is in Collectible Inc.’s best financial interest. The merger would lead to significant operating efficiencies which would in turn lead to an unprecedented growth in both net income and total assets. By structuring the financing as proposed in the previous section, the newly consolidated firm would meet the Quick Ration and Debt Service Coverage Ratios of at least 1.25 and 1.75 respectively; see table below for projected ratios. Key Bank Ratios Quick Ratio Debt Service Coverage Ratio 2015 1.35 7.46 2016 1.63 8.90 2017 2.00 10.47 2018 2.48 11.50 However, although financing the debt portion relying primarily on long term debt provides the desired ratios, our cash balance suffers as a result of having to pay out such large amounts due to loan repayment on an annual basis (for a 5 year period after the acquisition). Nevertheless, this remains the optimal recommendation. Page 5 Exhibits/Tables Table 1 AR Sales Days Determining the average collection period Starlight 2010 2011 2012 2013 2014 Average $1,502,000 $2,446,000 $2,258,017 $2,680,112 $11,011,549 $14,108,695 $14,517,014 $15,968,716 365 365 365 365 CP 50 2010 AR Sales Days 2011 $3,370,451 $32,886,109 365 CP 37 63 57 Collectibles 2012 2013 $4,567,295 $5,750,259 $33,497,044 $49,732,345 365 365 50 42 61 58 2014 Average $6,421,451 $54,705,579 365 43 43 Table 2 COGS INV Determining inventory turnover ratios Starlight 2010 2011 2012 2013 2014 Average $9,108,667 $10,219,260 $10,835,186 $11,918,704 $5,686,000 $5,655,000 $3,723,000 $4,086,600 $4,086,600 Inv Ratio 1.61 2011 $16,447,863 $5,083,700 $5,293,306 2.18 Collectibles 2012 $18,024,814 $2,215,248 2013 $24,335,337 $2,614,444 3.17 4.80 10.08 2010 COGS INV Inv Ratio Page 6 2.77 2.92 2.37 2014 Average $26,768,871 $3,986,147 8.11 6.54

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