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Chartered Professional Accountants of Canada, CPA Canada, CPA are trademarks and/or certification marks of the Chartered Professional Accountants of Canada. © 2020, Chartered Professional Accountants of Canada. All Rights Reserved. Les désignations « Comptables professionnels agréés du Canada », « CPA Canada » et « CPA » sont des marques de commerce ou de certification de Comptables professionnels agréés du Canada. © 2020 Comptables professionnels agréés du Canada. Tous droits réservés. 2019-09-27 Finance — Practice Case 3 Case (80 minutes) DeAngelos Foods Ltd. (DeAngelos) is a grocery store company specializing in high- quality fresh produce, and gourmet foods. Currently, there are three locations in downtown Vancouver. DeAngelos is a private company, with 100,000 common shares issued and outstanding to each of Brenda and Anthony DeAngelo (200,000 common shares total). The company follows accounting standards for private enterprises (ASPE) for accounting purposes. DeAngelos’ first store opened 20 years ago, when Anthony arrived in Canada from Italy. Six years later, a second location was opened, followed by a third location. All three stores have similar formats and layouts. All inventory items are sourced locally, where possible. Anthony and Brenda pride themselves on having developed stores where customers enjoy the shopping experience. DeAngelos has recently decided to expand outside of the downtown core and plans to open one new store in July 2020 and another in June 2021. The new stores will be similar in format and size to the current locations. You, CPA, work as a consultant for Henderson and Mulik (HM), a regional financial consulting firm. Anthony recently contacted David Henderson, a partner at HM, for financing advice for the expansion. DeAngelos requires $13.4 million to finance leasehold improvements and new equipment purchases for the new locations. Inventory and store opening costs can be financed via the current line of credit and cash flow from operations. Anthony has provided David with a three-year operating projection including both the income statement and balance sheet (Appendix I). These projections include existing financing but do not include any new financing alternatives for the expansion. It is now January 2020. David would like you to review the three new financing alternatives (Appendix II) and prepare an updated set of income statement and balance sheet projections for each alternative, using Anthony’s operating projections as a base (Appendix I). David also suggests that you provide the DeAngelos with qualitative considerations and a final recommendation. Your response should be no longer than 2,400 words, excluding any Excel files. Finance — Practice Case 3 Case 2 / 6 Appendix I DeAngelos Foods Ltd. Actual and forecast income statements prepared by Anthony DeAngelo For the years ended December 31 (Excluding new financing charges) (in ’000s) Actual Forecast Forecast Forecast 2019 2020 2021 2022 Sales $ 55,080 $ 64,444 $ 80,555 $ 91,833 Cost of goods sold (37,454) (42,533) (53,166) (60,610) Gross profit 17,626 21,911 27,389 31,223 Direct store expenses (12,570) (14,178) (17,722) (20,403) Pre-opening expenses — (1,800) (2,300) — Amortization (Note 1) (1,200) (1,239) (2,062) (2,859) General and administration (1,652) (1,702) (1,753) (1,906) Operating income $ 2,204 $ 2,992 $ 3,552 $ 6,055 Interest on line of credit (Note 2) (30) (32) (40) (50) Interest on mortgage (Note 2) (505) (502) (475) (448) Interest on new financing ? ? ? Earnings before income taxes and bonus 1,669 2,458 3,037 5,557 Amount available for management bonus (Note 3) (1,200) (1,958) (2,537) (5,057) Earnings before income taxes 469 500 500 500 Income taxes (Note 4) (70) (75) (75) (75) Net income 399 425 425 425 Opening retained earnings 299 698 1,123 1,548 Dividends — — — — Closing retained earnings $ 698 $ 1,123 $ 1,548 $ 1,973 Finance — Practice Case 3 Case 3 / 6 Appendix I (continued) DeAngelos Foods Ltd. Actual and forecast balance sheets prepared by Anthony DeAngelo As at December 31 (Excluding new financing) (in ’000s) Actual Forecast Forecast Forecast 2019 2020 2021 2022 ASSETS Cash (Note 5) $ 590 $ 400 $ 400 $ 400 Inventory 1,762 1,981 2,476 2,823 Prepaid expenses 360 644 806 918 Total current assets 2,712 3,025 3,682 4,141 Property, plant, and equipment (Note 1) 10,323 17,184 23,822 24,063 Total assets $ 13,035 $ 20,209 $ 27,504 $ 28,204 LIABILITIES Bank line of credit (Note 2) $ 800 $ 991 $ 1,238 $ 1,412 Accounts payable 3,078 3,496 4,370 4,982 Current portion of mortgage debt 450 450 450 450 Current portion of new financing ? ? ? Total current liabilities 4,328 4,937 6,058 6,844 New financing required (plug) — 6,590 12,789 12,728 Long-term mortgage debt (Note 2) 7,909 7,459 7,009 6,559 Total liabilities $ 12,237 $ 18,986 $ 25,856 $ 26,131 SHAREHOLDERS’ EQUITY Common shares $ 100 $ 100 $ 100 $ 100 Retained earnings 698 1,123 1,548 1,973 Total shareholders’ equity 798 1,223 1,648 2,073 Total liabilities and shareholders’ equity $ 13,035 $ 20,209 $ 27,504 $ 28,204 Finance — Practice Case 3 Case 4 / 6 Appendix I (continued) DeAngelos Foods Ltd. Forecast notes prepared by Anthony DeAngelo (in ’000s) Note 1: Property, plant, and equipment 2019 2020 2021 2022 Opening balance $ 9,700 $ 10,323 $ 17,184 $ 23,822 Additions (sustaining) 1,823 1,700 1,700 3,100 Additions (new equipment) — 1,400 1,400 — Additions (new leaseholds) — 5,000 5,600 — Amortization (12%) (1,200) (1,239) (2,062) (2,859) Closing balance $ 10,323 $ 17,184 $ 23,822 $ 24,063 Assume an average amortization rate of 12% on the opening property, plant, and equipment balance on a go-forward basis. Capital cost allowance approximates amortization. Note 2: Existing financing The line of credit with King Bank allows a maximum limit of up to 50% of the inventory and requires that the current ratio be at least 0.6:1. Interest on the line of credit is incurred at 4% annually. Additional unsecured operating funds can be borrowed at 9% annually. The existing mortgage, also with King Bank, requires principal payments of $450,000 annually on December 31 and is secured by real estate of the existing three locations. Interest on the existing mortgage is incurred at 6% annually. All loans from King Bank include personal guarantees from the shareholders. Note 3: Management bonus Anthony and Brenda DeAngelo do not take a salary, and instead live off of annual bonuses. The company prefers to keep income before taxes at $500,000 to maximize the small business deduction and pay the lowest rate of tax in the corporation. Note 4: Income tax The company’s current tax rate is 15%, assuming $500,000 or less of taxable income. Above this threshold, the effective corporate tax rate is 25%. Note 5: Cash A minimum cash balance of $400,000 is required for cash floats and purchases. Finance — Practice Case 3 Case