MGT 404 – ASSIGNMENT #2 ALLGOMOTIVE INC (AGM)

MGT 404 – ASSIGNMENT #2 ALLGOMOTIVE INC (AGM)

MGT 404 – ASSIGNMENT #2 ALLGOMOTIVE INC (AGM)

AllGoMotive Inc (AGM) was founded by Leslie Smith in 2012. A chemical engineer bytraining, Leslie started the company after developing aluminum-air technology that could extendthe life of lithium-ion batteries. This technology (which she named, “the battery extensionsystem”) was used in “mission-critical” batteries and had recently been applied for use in electriccars. In practical terms, the technology could extend a typical car battery’s life. On average, thisextension allowed it to operate for up to 1,000 miles between charges. Initial capital for thecompany was provided by Leslie and three family friends, with Leslie being the majorityshareholder. Additional debt financing was provided by a regional bank.AGM had just finished a great fiscal 2014, and things continued to look bright for itsprojected fiscal 2015 (which began on November 1st, 2014). First, just before its 2014 year-end,AGM signed 5-year agreements with two of the largest electric car manufacturers in the country.Importantly, both manufacturers were quite profitable despite the fact that electric cars had yet togain a real foothold in the marketplace. While some of the pricing terms had yet to be ironed outfor the last two years of each contract, Leslie was optimistic about the contracts’ potential todrive future growth in the company.Second, Leslie had spent time over the last year improving on AGM’s existing product.In particular, she had developed a battery extension system that would now allow car batteries tolast up to 2,000 miles between charges. She had already branded the new product as, the “BatteryExtender 2000” (code named BX2000). The patents for the new product were likely to becompleted somewhere near the end of fiscal 2015. Leslie was optimistic that the new technologywould not only open up more growth opportunities for AGM, but also make it more difficult fornew entrants to compete with her company.Finally, Leslie had approached her bank about obtaining additional debt financing at thebeginning of fiscal 2015. The additional financing (which would be added to AGM’s existingloan from the same bank) would help fund the company’s new growth initiatives and give thecompany sufficient operating flexibility. To date, AGM’s bank loan had been structured so thatAGM would not have to pay down any of the loan until fiscal 2020 (although AGM would haveto pay applicable interest on the loan in every year). As part of the negotiations for the additionalfinancing, the bank wanted to restructure the terms of AGM’s loan. Specifically, on top ofproviding additional debt financing, the bank agreed to charge AGM a lower interest rate infiscal 2015 than it had been charged in fiscal 2014. However, the bank also insisted that AGMwould now have to start re-paying back substantial portions of its debt by the end of fiscal 2016instead of fiscal 2020. Moreover, AGM would be charged a higher interest rate on its loan (i.e.,20%) starting at the beginning of fiscal 2016. Leslie thought she needed the extra financing tohelp her firm grow, but wasn’t entirely sure about how the additional financing would affectother elements of her business. In particular, while the new loan terms seemed to yield somebenefits for fiscal 2015, they also appeared to generate some drawbacks for fiscal periods beyond2015.You have been friends with Leslie for years. It is now November 2nd, 2014 and you justfound the following email in your inbox:Exhibit 1: Assumptions and expectations for fiscal 20151Fiscal year end for AGM is October 31st. Additional assumptions and expectations are listedbelow.1) According to the new terms negotiated with the bank, the bank will provide AGM withan additional $3,680,000 of debt financing at the beginning of fiscal 2015. Interestpayments totaled $115,000 in fiscal 2014, and interest payments are expected to increaseto $460,000 in fiscal 2015.2) During fiscal 2014, AGM paid out a total of $3,450,000 in cash relating to wages. Inaddition, wage expenses were allocated as follows. 80% of wage expenses were allocatedto the manufacturing of the battery systems and the remaining amount was allocated toexecutive salaries. The expectation is that AGM will end up paying $4,855,000 in cashrelating to wages during fiscal 2015 (and once again, in 2015 80% of the total wageexpenses will be allocated to manufacturing the units, and 20% will relate to executivesalaries).3) AGM ended up making $1,725,000 in cash payments for inventory materials in fiscal2014. In fiscal 2015, cash payments for inventory materials are expected to be 225% ofwhat they were in fiscal 2014.2 This increase is not related to an increase in input costs,as AGM is expecting to get a unit discount on some of its inputs next year. This increasearose because AGM felt it needed to stock up on product to keep up with expecteddemand.4) Cash collected from customers in fiscal 2015 is expected to increase by 20% from the$6,612,500 collected in fiscal 2014.5) AGM’s lawyer (Mark Eagleton) has been particularly impressed by AGM’s futuregrowth prospects. As a result, Leslie expects Mark to do all of AGM’s patent filing forthe BX2000 in 2015 in exchange for shares in the company. The value of the legal workto file the patents in multiple countries was expected to reach $250,000, and the patentswere expected to be filed at the end of fiscal 2015. In addition, AGM is expecting to issue$230,000 of additional shares in fiscal 2015 (for cash). No shares were issued in fiscal2014.6) On November 1st, 2014, AGM got rid of one of its original pieces of equipment: theAlO2 Purifier Max. Leslie commented that, “We realized on November 1st that themachinery was completely useless. The net carrying value on the balance sheet was$200,000 and I ended up immediately selling it for scrap for $10,000.”1The impact of all assumptions has been incorporated in to the pro-forma financial statements for fiscal 2015.By “cash payments for inventory materials are expected to be 225% of what they were in fiscal 2014”, we meanthat if cash payments for inventory materials were $1 in 2014, they are expected to be $2.25 in 2015.27) Cash purchases of equipment were $230,000 in fiscal 2014 and are expected to be$705,000 in fiscal 2015. All of the firm’s property, plant, and equipment is deemed to begeneral purpose (i.e., none of the equipment is explicitly used for manufacturing).8) Rent payments for office space are expected to increase to $450,000 in fiscal 2015. AGMpaid out $300,000 in rent payments during fiscal 2014.9) During fiscal 2014, AGM paid out $160,000 in insurance premiums. After switchinginsurance companies and negotiating higher deductibles, insurance premiums paid infiscal 2015 are expected to be $150,000.10) Dividends declared and paid were $287,500 in fiscal 2014 and are expected to be$345,000 in fiscal 2015.11) Taxes are always paid in full during the following fiscal year. AGM’s effective tax rate is24%.12) The firm uses the periodic inventory method to account for COGS.13) Assume that all sales are initially made on account.REQUIRED:1.) Create the income statements for the fiscal 2015 pro-forma [NOTE: please use the sameformat for the income statement as in Exhibit 2]. (13 points)2.) Create the statement of cash flows for the fiscal 2015 pro-forma using the indirectmethod. (22 points)3.) Are the types of cash flows observed in your answer to question 2 consistent with thecurrent stage in the company business cycle? Explain. (2 marks)4.) Leslie is concerned about the bank loan restructuring in 2015. Citing your analysis above,do you think it’s necessary for AGM to incur additional debt in 2015? Explain. (2 marks)5.) Calculate the inventory turnover ratio, accounts receivable turnover ratio, fixed assetturnover ratio, total asset turnover ratio, debt-to-equity ratio, interest coverage ratio,return on equity, and return on assets for both 2014 and 2015 (pro-forma). Additionally,provide a formula to illustrate how you calculated each ratio. (8 marks)6.) Following your discussion of financial statements with Leslie, she comments, “That’sfunny. Even though we were expecting higher profits in 2015, return on assets is lower in2015 than in 2014. What’s even stranger is that return on equity is higher in 2015 than in2014. I have no idea what’s going on!!” Using tools you’ve learned in class, explain theseresults. (6 marks)7.) Discuss how the inventory turnover ratio, accounts receivable turnover ratio, interestcoverage, current ratio and quick ratio have changed between 2014 and 2015 (pro-forma).In each case, please indicate whether AGM should be concerned about the trend theyobserve. Use case points to back up your answers. (5 marks)8.) “Hmmm… looking at my statement of cash flows it looks like my cash flow fromoperations might have been higher if I sold the machinery for… less? Is that correct?Cash flow is important to me, maybe I should have sold the equipment for one dollar.Does that make sense?” All else equal, if Leslie had sold the machinery for $1, whatwould her cash flow from operations have been? Illustrate how you got to your answer.All else equal, if Leslie had sold the machinery for $1, what would her total change incash flow have been? Illustrate how you got to your answer. (4 marks)9.) “Before my accountant quit, she mentioned that I could have actually had a projectedincrease in my ROA from fiscal 2014 to fiscal 2015, had I (1) not sold my equipment and(2) chosen to account for the equipment on my balance sheet in a very aggressivemanner. I’m not sure how that’s possible, given that not selling my equipment wouldhave just added more assets to my balance sheet.” Explain the accountant’s reasoningusing tools learned in this class. (4 marks)Other notes:• Please submit your assignment in PDF form. Please ensure that you put your name on theassignment.• This assignment is to be completed individually and with no discussion with yourclassmates• There are 66 total marks available for this assignment.• This assignment is worth 15% of your final mark.• When calculating ratios use the ratio definitions discussed in class. However, I appreciatethat there may be different ways to define ratios based on information presented in thecase. Thus, remember to provide a formula to illustrate how you calculated your ratios.• When discussing or explaining your reasoning for any of your responses, a good rule ofthumb is to use no more than 2 sentences per mark available (i.e., please do not be overlyverbose when discussing your answers).• There are often different ways to interpret the information presented in any case. If thereare any concerns on how to answer a given question due to a perceived ambiguity in thiscase, please make a note of the assumptions you used to generate your answer. If yourreasoning is sound, you will receive full credit.Exhibit 1: AGM Balance Sheet for 2013, 2014, and pro-forma 2015For fiscal year ending October 31stAssetsCurrent AssetsCashAccounts receivableInventoryPrepaid rentPrepaid insuranceTotal Current Assets2015 pro-forma201420131,449,8901,200,0003,300,000138,00092,0006,179,890540,500920,000471,500126,500115,0002,173,500230,0001,035,000437,000115,000138,0001,955,000Non-Current AssetsEquipment (net)PatentTotal Non-Current AssetsTotal Assets1,335,875250,0001,585,8757,765,765977,500977,5003,151,000805,000805,0002,760,000Liabilities and Shareholders’ EquityLiabilitiesCurrent LiabilitiesAccounts payable (for inventory)Interest payableSalaries payableTaxes payableShort term portion of loan payableTotal Current Liabilities747,500115,000287,500157,8301,340,0002,647,830598,000115,000195,50099,3601,007,860345,00092,000172,50034,500644,000Long-term LiabilitiesLoan payableTotal Liabilities3,490,0006,137,8301,150,0002,157,8601,150,0001,794,000Shareholders’ EquityCapital stockRetained earningsTotal Shareholders’ Equity1,055,000572,9351,627,935575,000418,140993,140575,000391,000966,000Total Liabilities and Shareholders’ Equity7,765,7653,151,0002,760,000Exhibit 2: AGM Income Statement for 2014AGMIncome StatementFor fiscal year ending October 31stSalesCOGSGross ProfitOperating Expenses:RentInsuranceDepreciation ExpenseInterest ExpenseSalaries ExpenseOperating Expenses:Gains or LossesIncome before taxesIncome taxesNet Income20146,497,500.004,721,900.001,775,600.00288,500.00183,000.0057,500.00138,000.00694,600.001,361,600.00414,000.0099,360.00314,640.00

 

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