PA2 Issues

1. Business Expansion
Example # 1
Overall Analysis of Proposed U.S. Expansion
Expanding into the U.S. market and opening up a manufacturing plant in the United
States is a big decision for UTI. I have developed a list of strengths and weaknesses
immediately below.
Strengths
Establishing a U.S. manufacturing plant will allow UTI to promote its products as
assembled in the U.S.A., attracting more American consumers.
The U.S. market appears to have considerable revenue potential, resulting in
increased revenue for UTI.
The U.S. consumer base is substantially larger than the Canadian consumer base.
Strategically, UTI needs to explore new markets, since sales in Canada are
plateauing.
By having a plant in the United States, shortages to American consumers should be
reduced or eliminated.
Weaknesses
Focusing on the U.S. market may take time and energy away from the Canadian
market, and potentially harm UTIs Canadian performance. Canadian consumers
may suffer in the long term.
American consumers may still be reluctant to purchase UTI products if these
consumers find out that the U.S. Company is owned by a Canadian parent.
Expanding into the United States creates a foreign exchange currency fluctuation
risk.
Operating in a foreign country involves a significant amount of risk. UTI would need
to ensure it becomes familiar with and abides by all the local manufacturing, tax, and
business regulations.
Based on my analysis, I see that this expansion would offer UTI many opportunities.
However, UTI needs to carefully consider all the risks of expansion and consider ways to
mitigate these risks. In this regard, I would recommend that UTI perform a sensitivity
analysis considering the worst-case scenario if sales in the United States did not triple,
but stayed at current levels. If you would like this done, please let me know and I would
be able to start working on such an analysis. As well, a back-up or contingency plan
should be prepared. If these additional steps are taken and all the risks are mitigated to
an acceptable level, then I would recommend that the U.S. plant expansion should
proceed.
Financial Accounting and Tax Issues

If UTI forms a wholly-owned U.S. subsidiary, it would need to prepare consolidated

financial statements that include the operations of its U.S. subsidiary. As UTI would have
over 50% voting control, we would treat both companies as one economic unit.
The U.S. subsidiary would be required to file U.S. corporate tax returns as well as any
applicable U.S. state tax returns. Transactions between UTI and the U.S. subsidiary
would need to be carried out at arms length, in order to comply with the transfer pricing
rules set out by both the Canadian and U.S. tax authorities. Since U.S. corporate and
state tax issues as well as transfer pricing issues are areas beyond my knowledge base,
I would recommend that we confer with a cross-border tax specialist to address these
issues. Finally, this U.S. subsidiary would be considered a controlled foreign affiliate of
UTIs; thus, UTI would be required to file an annual information return (Form T1134-B) to
CRA, disclosing various pieces of information about the U.S. subsidiary, include details
of any inter-corporate loans.
Example # 2
Impact on financing
As per plan the total expansion will require $7.5M, which will be financed through debenture
issue $6M and the rest $1.5 through debt financing. Considering current year financial
performance and recent economic recession it should be challenging to obtain money from the
market against issue of debenture, because the investor will closely analyze the financial results
while making their investment decision.
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If we issue debenture, will be treat as a long term liability and as a result our debt-toequity ratio will increase. Note that, our current debt-to-equity ratio is already high.
Moreover, considering recession and financial performance since the investors taking
high risk, they might demand higher return. The only benefit we may get through
debenture issue is the deductibility of interest payment for tax purpose.

On the other hand if we manage fund through debt financing, would be very costly since
prospective lenders might demand higher interest based on our poor financial
performance. In addition, existing lenders might force us to repay their debts resulting
cash difficulties and our ability to continue as a going concern. However, interest
payments are tax deductible expenses and there is no possibility of losing control over
the company.

Based on the above financing analysis, I would recommend to redesigning our financing
structure like issue of common shares which will give us the benefit of paying dividend instead
of interest. Dividends payable at managements discretion but interest must be paid regularly.
Moreover, it is recommended that the company should explain the following issues to the
investors:

The overall financial position of the company for 20X5 is weak compare to 20X4. But
it is mainly because of the recent economic recession. The situation will improve
once the recession is over and expansion project implemented.

With the implementation of expansion project, maintenance cost will reduce

significantly which will help to reduce the production cost and increase gross margin.

Expansion project will help to maintain the product quality and to retain the present
market share.

In view of the above, I will appreciate your comments regarding the issues I raised or any other
concern you have.
Example # 3
General:
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Expansion is risky
Need experienced staff
Personal motivation important
Current market share could be lost if the company doesnt expand.

To access the feasibility of the expansion using three or more of:

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Sensitivity analysis
Net Cash Flow assessed
NPV

2. Cash Flow
Example # 1
We currently are experiencing cash flow difficulties. We are operating in a low liquidity position
and this situation is not likely to improve shortly. We require in the short term funding to get us
through until we see the benefits from longer term working capital management improvement.
We have several options to consider, as follows:

Bank Loan: We can approach our bank to extend our operating line of credit.
Although we are using our full line of credit, we would need to re-negotiate a new
agreement that may likely be at a higher interest rate. The advantage of bank
financing is that the funds will be available immediately if it is approved.
Factor Receivable: We can sell our existing accounts receivable balance to another
company at a discount. This will also provide immediate funds. However, the cost of
the discount may high.
Issue more share capital: We can issue more shares at this point, without adding a
lot of value to the company.

I believe our best option with the least risk would be to go to the bank for financing.

3. Profitability
Example # 1
It seems that product costs have consequently not dropped and the lower than-expected sales
volume has failed to achieve the economies of scale and the synergies required.
The production department should review all costs in order to identify potential cost-saving
strategies. However, the more likely increase to profitability will come through increased sales. If
Mallfort can increase sales volume without significant additional costs, it would be the best way
to improve the profits. However, if the higher volumes resulting from discounted prices do not
reach breakeven point, Mallfort could potentially end up with a loss instead of a profit. Therefore
any discounts offered should take into account selling costs and maintain gross margin in the 25
to 27% range. Mallfort should review its product lines, market share, and competition to identify
potential new markets or new marketing strategies. The company should also assess the
viability of continuing to maintain sales and distribution centres, as well as timberland, milling,
and manufacturing facilities. Links in the vertical integration chain that are not profitable could
be potential candidates for divestment. Mallfort should consider the advantages and
disadvantages of vertical integration. Non-financial factors such as control of pricing/delivery in
the supply chain and flexibility to seek lowest price should also be considered.
The main issue facing Mallfort is poor sales. If management believes it can double its sales with
these new stores, it should invest in them since it can then enjoy the economies of scale from its
state-of-the-art production facilities.
However, Mallfort should carefully evaluate if the sales projections are realistic in light of the
economic conditions and of the probability of the new stores success if they replace their
existing products with those manufactured by Mallfort.

4. Business Merge
Example # 1
This report will outline the issues regarding the proposed merger.
Key Performance Indicators (KPIs)

Currently, Atled Family Services (AFS) has no KPIs to measure the success of the organization.
KPIs are an indicator of the success of an organization, or of how successful a particular activity
is. By not measuring our successes, we are missing out on learning what we do well, and what
we need to improve upon. KPIs are also a good way to improve our reputation with
stakeholders. I note as well that the Greater Atled Food Bank (GAFB) does not use KPIs either.
If this merger goes ahead, it is imperative that we track our success, especially when reporting
to our stakeholders. They need to be aware that we are just as successful as, or even more
successful than, we were prior to the merger. I recommend that the following KPIs be tracked,
effective immediately:
Number of families served per year
Cost to run the program per person served
Number of new clients
These KPIs will enable us to show our stakeholders that we are successful year over year by
showing growth in number of families served, that new clients are utilizing our services, and that
the costs to run the program are stable, and the programs are fiscally responsible.
Information Systems and Accounting Issues
Both AFS and GAFB use accounting systems to track their financial information. If the
organizations merge, to gain efficiencies, one system will need to be used. This is especially
true of the fixed costs that will be incurred by the merged entity, but will need to be split out
proportionately. Both organizations have fixed costs, and when looking at the information in
Exhibit 1, it appears that some of the fixed costs will be eliminated upon merging. Considering
the excess space at our location, rented office space, utilities, and telephone will no longer be
needed by GAFB, gaining efficiencies and freeing up cash flow. There is also a chance that we
may be able to get out of some of the long-term leases. Once merged, the remaining fixed costs
will need to be systematically allocated between the two entities. A method needs to be chosen
that will best reflect the usage of these costs.
Risks
Although there are efficiencies that can be gained through this merger, there are also many
risks that I have identified that need to be mitigated before the merger is considered.
The first and most important risk is that both organizations have different mandates. Although
both help people, AFS assists children and youth with developmental delays, while GAFB helps
low-income individuals meet their basic food requirements. Although both are good causes, this
merger of two seemingly different organizations may be seen negatively in the community
because of the radically different needs of the user groups. Donations may fall even further if
the community doesnt understand the reasons for the merger.
In any organization, change needs to be managed with care. When staff at both organizations
hears about the merger, there will probably be fear of the future, and not knowing what is going

to happen will only increase this fear. We may have key employees leave either organization
since they dont know what the future holds. There will be fear of job loss, especially because
this merger is about gaining efficiencies. We have an opportunity to use this merger to
streamline processes, and at the same time we may need to use it to eliminate redundancies
and lay off staff.
Other Issues
As I am not an expert in mergers, I recommend that we retain a lawyer who specializes in this to
assist us with the implications of the merger. This professional may also identify further risks
that I have overlooked.

5. Bonus Plan
In order to increase sales and profitability over the baseline financial projections bonus plan is
good motivation. Moreover, it will help to retain experience employees and long term planning.
In addition with the bonus plan, I recommend to consider following alternatives:

We should offer stock option to the managers with long term commitment towards
company. This stock option should be exercised by managers after a considerable
amount of time.
We should offer manager bonus based on average net income over several years.
Introduce balance scorecard which includes qualitative and quantative aspects of
performances.

Tax implication and the timing of the bonus payout should be carefully planned.

6. Dividend Declare
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Company should distribute a reasonable amount as dividends to its members and retain
the rest for its growth and survival.
Consider general state of economy (during uncertain economic and business conditions,
during the prosperity, during the inflation).
Stable dividend policy is advisable. It refers regular payment of certain minimum amount
as dividend.

7. IPO Issues
To grow and expand the operations of our company, you are considering whether to issue an
initial public offering (IPO). To assist with this consideration, I have identified the advantages
and disadvantages of issuing an IPO as well as the financial reporting and audit requirements if
our company were to operate as a public company.
Advantages of becoming a public company include increasing our access to capital, which can
help decrease the leverage of the company and improve the debt-to-equity ratio and other

competitive financial ratios, such as the current ratio. Improving our financial leverage and
increasing the amount of cash in our company from the sale of shares can help reduce debt and
negotiate better interest rates on outstanding debt.
As an IPO can be distributed to a variety of investors, consumer awareness will increase, which
can also increase sales. In addition, employee motivation may improve as there will be more
opportunities for growth and promotion. Offering employee stock-option plans will be a good
alternative to excessive wage increases and will serve as an incentive for employees to have a
sense of ownership and align their long-term interests with that of the company increasing
the profitability of the company.
A disadvantage of becoming a public company is increased accountability. A public company
must provide more financial reporting and disclosure information, such as disclosing the
compensation of executive officers and preparing an MD&A report and interim financial
statements. There will also be a change in control as our company will need to report to, and
receive approval from, shareholders for major business activities, rather than just yourself.
The costs to go public can be substantial. Preparing an IPO incurs legal, underwriter, securities
registration, consulting, and auditing fees. We should consider our tax plan, as a private
company may receive different tax incentives than a public company (such as the small
business deduction). Our annual auditing fees will increase when we are a public company, as
we will need to comply with increased financial reporting and auditing requirements. SML should
also consult with its auditors to discuss tax planning and determine an effective tax strategy
both for its Canadian operation and any future expansion globally.

Financial reporting requirements will be more extensive and stringent if SML becomes a public
company. An annual audit will be required. A private company is permitted to use Accounting
Standards for Private Entities (ASPE) or can elect to use International Financial Reporting
Standards (IFRS), but a public company must use IFRS. Thus, if we are planning to issue an
IPO, we can elect to adopt IFRS even before SML becomes a public company and have an
audit done. This may help to give the owners, underwriters, and other interested parties a better
financial picture of the company and provide a basis of comparison from one year to the next.
Currently the financial ratios are based on ASPE and meet the requirements under SMLs debt
covenant. However, switching to IFRS may impact on these ratios and comparability from one
year to the next. SML should alert the bank of this changeover and renegotiate covenants.

8. Conflict among employees

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COO will take the initiative

Productivity lose
Staff turnover
Company reputation

9. Stock option plan

While reviewing the 2006 books in preparation for the audit, I have noticed that the option
expense was booked in 2006 when the options were granted. Actually we need to defer the
expense in 2006 and amortize it over the vesting period of 2007 and 2008. This will put us in
compliance with GAAP for the audit. We will also be required to include a note of disclosure in
the financial statements detailing the number of options outstanding, the strike price, and value.
It may be better to use one of the option pricing methods such as Black-Scholes or binomial
option pricing to determine the expense to our company, and evaluate the estimate each year
end and adjust as necessary.
Stock options are more forward looking incentives that motivate key employees to make
decisions that will reflect favourably on future share price. In fact, options are mostly used as
part of compensation, rather than as a bonus.
There are also many factors that influence stock price that are beyond the control of employees,
such as interest rates or a general economic downturn in the market.
Example:
Company issue 100 option @10/options, exercisable after 2 years.
During exercise FMV of options @12 CCPC stock option holder can defer the employment
income upto the final sale of the share.
During final sale if option price change @16 based on $4 capital gain will be calculated.

10.

Business Valuation

There are several valuation methods used to provide a valuation of the business. The most
common would be a discounted cash flow method. This method involves projecting future cash
flow and discounting it at a rate equivalent to the expected return on the investment.
Another common method of valuation is using a multiple factor of key ratio.
11. Inventory Valuation
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As a public company we are following accounting reporting standard IFRS. As per IFRS
inventories should be valued based on lower of cost or net realizable value.
Second and reject items should be treated as inventory and included in the balance
sheet as current assets.
Any loss due to the lower market price should be expense in the income statement.
With respect to recognition of inventory wastage of materials, direct labor, and other
production costs must be expensed in the income statement for the period.
Write down of inventory is expensed through cost of goods sold.

12.

Audit Plan

13.

Financing Option

14. Make or buy

15. Variable vs. Absorption costing
16. SW Purchase

17. Employee vs. Contractor

18. Investment Decision
19. Foreign Currency
During the reporting time, parent company needs to translate their subsidiaries financial
statements to their functional currency.
IAS 21

Monetary items (cash, A/R) as per rate of the balance sheet date. Any gain or loss
should go to the income statement.
Non-Monetary items (PPE) as per historical rate. Gain or loss should go to the OCI.
Will not be taxable until realized.
Income statements item as per average rate.
Need proper disclosure of the gain/loss

20. Not for profit

21. Transfer pricing
Cost based, market based and negotiated.
22. Working Capital Management
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To improve working capital we should look accounts payable/inventory and accounts

receivable.
Adequate working capital helps:
Uninterrupted flow of production
Creating and maintaining goodwill
Arrange loan from bank
Avail cash discount on the purchases
Ability to face crisis

23. Risk Management

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Business Risk: Larger manufacturers have plan to develop the same product, which will
increase our business risk. In order to mitigate the risk we should continue to remain
innovative by undertaking research and developing projects. We should focus on gaining
customer loyalties by increasing quality and service.
Financial Risk: If we take loan from the bank, there is no risk to lose the control over the
company. Moreover, the interest payments against loan are tax deductible.
Nevertheless, the loan would increase our financial risk as a result of using debt.
Product quality Risk: Due to mixed/different inputs used to manufacture the final product.
Economic Risk: Since the product is much more expensive than regular product, in time
of recession, people may not willing to pay the extra price.
Political Risk: Government may withdraw the tax credits.
Foreign exchange Risk: Mitigate this risk hedging. The ways of hedging are future,
forward & options. However we may use the natural hedging (inter company
transactions).
Foreign Operation Risks: PEST (Political, Economical, Social, Technological)
Supplier Risk: If we import any items from China or India.

Long term strategic planning is required to deal with risks.