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The Awesome Products Business Valuation Case Awesome is a small closely held company operating in the United States. Assume you are in the early stages of preparing a business valuation on Awesome Products to assist a potential purchaser.. Included in the case is a copy of Awesome Products, Inc. Unadjusted Income Statement and Balance Sheet and Operating Expense detail for the periods ending December 31st; all numbers are in thousands. All questions on this case use the attached data as basis. Instructions: Complete each of the exercises. As always you will be graded on both content (correctness) and organization of your answers. 1. Based on the information given, prepare the normalization entries for the years 2010 2014. Explain your reasons for each normalization entry. 2. Using the data you created in #1, a. Prepare normalized and common size balance sheets for each year from 2010 - 2014; and (you may want to use excel but please remember do not go too far over to the right. This makes it very difficult to print out) b. Prepare a normalized and common size income statement for each year from 2010 - 2014. (you may want to use excel but please remember do not go to far over to the right. This makes it very difficult to print out) 3. Compute the following ratios listed using the normalized data for each of the 5 years. Ratios to be calculated are: 1. Growth Ratios 1. Sales Growth Percentage 2. Earnings Growth Percentage 11. Cost Control Ratios 1. Cost of Sales/Sales Industry Average n/a n/a n/a 2. Gross Margin or Profit 41.2 3. Operating Expenses to Sales 37.4 4. Operating Margin or Profit 111. Turnover Ratios 1. Receivable Turnover 2. Inventory Turnover 1v. Profitability Ratios 1. Return on Assets 2. Return on Equity v. Risk 1. Debt/Equity Percentage 2. Current Ratio 3. Interest Coverage 3.8 101.7 3.5 7.4 16.8 0.5 1.7 3.5 4. Trends: Analyze the ratios you calculated for each of the 5 years. Analyze and explain why you believe they are indicative of issues (positive or negative) to your planned valuation of Awesome Products Inc. 5. Using the normalized income statements developed above, estimate future income. State why you believe the method you selected for estimating future is the most appropriate for this company. 6. Based on the above exercises and a capitalization rate of 20%, calculate, using the interest capitalization method, the value of Awesome Products, Inc. Information needed for normalization entries You have discovered the following information after reviewing the financial statements and other company documents, and interviewing management. 1. Net Sales During the period 2010 through 2014, the company has expanded their product line and opened new stores. This caused the increase in sales during this period. An analysis of the information shows the following: Year Number of New Stores Increase in Sales 2011 20% 2012 2 10% 2013 0 2014 2. 1 2 10% Cost of Sales Products purchased from the same supplier. Different cost of sales percentages, due to different product lines. 3. Salaries and Wages Generally, the increase in salary expense was caused by hiring additional employees to work in the new stores. Included in the account, Officers' Compensation, is the salary of the owner, George Bigshot. His salary for the 5 year period has been: 2010 - $375,000 2011 - $400,000 2012 - $475,000 2013 - $500,000 2014 - $535,000 You have compared his salary to industry data, and the amount he receives appears to be high. His compensation appears to be 15% above the industry norm. June Bigshot is an employee and earns $35,000 per year recorded in Other Salaries & Wages. From interviews and physical observation, it does not appear that she has any responsibilities and is rarely at the business location. When Awesome opened the last 2 stores in 2014, they hired experienced managers. Each of these manager's earn $5,000 more than the managers in the other stores, this amount appears to be $3,000 above the norm in the industry. 4. Selling Expenses This category includes numerous expense items. The Advertising and Promotion category is significantly higher in 2014 compared to previous years. The marketing manager told you Awesome redesigned all their literature in 2014. The cost of the design work and printing costs was $550,000. After careful analysis, you notice that the Travel and Entertainment category has increased steadily since 2010. After asking questions, you discover personal trips that were paid for by the company. The annual amount for these trips, is as follows: 2012 = $80,259; 2013 = $120,000; and 2014 = $200,000. Other Selling Expenses, includes expenses for a condo owned by the company. The condo was acquired in 2010, and was capitalized as an Investment on the Balance Sheet (see Investments below). The company has incurred $20,000 per year for the upkeep of the condo from 2010 - 2014. Also, in this category there is $23,000 in 2013 and $500,000 in 2012 related to an employee strike. The strike was settled and management does not anticipate any strikes in the future. Related to the strike the legal fees to handle the situation were $100,500 in 2013 and $80,750 in 2012. The legal fees were included in the General & Administrative section. 5. General & Administrative The insurance account has increased significantly. Most of the additional cost is due to the opening of the new stores. However, there is $10,000 per year of property insurance on the condo, and $12,500 per year of real estate taxes for the condo. The two stores opened in 2014 are in a specialty area, and the rent paid is significantly higher than the other stores. The rent for each of these stores is $48,000 per year, and the average rent for the other stores is $30,000 per year. The use of office supplies appears to be very inconsistent. The amount fluctuates greatly from year to year, but you could not find any reason for this. In each year, that new stores were opened, the company took the maximum deduction for Section 179 expenses of $18,500. This amount is recorded in the Depreciation Section. Under normal circumstances these assets would be depreciated over a 5 year period using straight line depreciation. 4 6. Investments The condominium was acquired in 2010 for $190,000. The condominium was depreciated on the straight line basis over 30 years, starting at the beginning of 2010 with the land valued at $10,000. The balance in the Investment account was reduced accordingly, instead of showing accumulated depreciation and the depreciation expense was recorded in Other Expenses under the General & Administrative category. The balance in the Investment account represents stock that Mr. Bigshot trades on a regular basis. No gains or losses were incurred on these investments. 7. Dividends Dividends of $100,000 were paid in 2011. 8. Advances from Affiliates This account represents funds borrowed from another company owned by Mr. Bigshot. Awesome pays a fair rate of interest on the funds borrowed. 5 ii'ii' 0 . 1 '''' 12/31/14 ,, ,, ,', ,', ASSETSASSETS Current Assets :Current Assets : CashCash $$ 97,326 Accounts Receivable-TradeAccounts 191,952 Receivable-Trade Rec.-Related CompaniesRec.-Related 1,446 Companies InventoryInventory 1210965 Prepaid ExpensesPrepaid Expenses 63,303 Other Current AssetsOther Current 48,023 Assets Total Current Assets 1613015 Property, Plant and Equip Furniture and Fixtures Leasehold Improvements Transportation Equipment Total Less: Accumulated Depreciation Net Fixed Assets Awesome Products SCHEDULE 1SCHEDULE 1 Awesome Products Unadjusted Balance Sheets (UNAUDITED & ALL NUMBERS IN THOUSANDS)(UNAUDITED & ALL NUMBERS IN THOUSANDS) 12/31/2013 12/31/2012 12/31/2011 12/31/2010 12/31/2014 12/31/13 Preparer's Name 12/31/12 12/31/11 12/31/10 3.28%3.28% 5.10%5.10% 0.48%0.48% 29.65%29.65 % 2.47%2.47% 0.17%0.17% 41.15 4.21%4.21% 7.43%7.43% 0.37%0.37% 30.28%30.28 % 3.38%3.38% 0.00%0.00% 47.64 3.71%3.71 % 9.09%9.09 % 0.35%0.35 % 27.66%27. 66% 3.59%3.59 % 1.39%1.39 % 47.79 38.00% 43.22% 0.77% 81.99% -33.05% 48.94% 37.58% 45.90% 1.35% 84.83% -30.00% 54.83% 32.47% 49.39% 2.04% 83.90% -36.26% 47.64% 27.51% 45.15% 1.88% 74.54% -27.28% 47.26% 0.25% 3.41% 3.66% 0.06% 3.96% 4.02% 0.78% 5.91% 6.69% 0.40% 6.55% 6.95% 100.00% 100.00% 100.00% 100.00% Percentage ofPercentage of Total AssetsTotal Assets 86,898 161,327 6,046 977,301 58,088 41,873 1,331,533 86,898 128,641 12,070 748,316 62,313 4,296 1,038,396 75,237 132832 6,691 541,703 60,476 816939 62,697 153,497 5,890 467,094 60,635 23,458 773,271 3.09%3.09% 5.74%5.74% 0.22%0.22% 34.79%34.79 % 2.07%2.07% 1.49%1.49% 47.4 2.74 5.39 0.04 34.02 1.78 1.35 45.32 1,304,204 1,636,779 35,471 2,976,454 (1,134,534) 1,841,920 1,067,507 1,214,225 21,594 2,303,326 (928,544) 1,374,782 948,317 1,158,183 34,164 2,140,664 (756,934) 1,383,730 580,770 883,539 36,566 1,500,875 (648,670) 852,205 464,556 762,516 31,727 1,258,799 (460,714) 798,085 36.64% 45.99% 1.00% 83.63% -31.88% 51.75% 14,188 90,049 104,237 7,018 95,849 102,867 1,412 99,942 101,354 13,926 105,695 119,621 6,750 110,673 117,423 0.40% 2.53% 2.93% $ 3,559,172 $ 2,809,182 $ 2,523,480 $ 1,788,765 $ 1,688,779 100.00% Other Assets : Cash Value-Life Insurance Investments Total Other Assets Total Assets LIABILITIES & EQUITY Current Liabilities: Current Portion - LT Debt Accounts Payable 1 Due Bills & Gift Certificates Advances From Affiliates Accrued Salaries ' Income Taxes Payable Total Current Liabilities . , $ 52,307 603,544 21,357 199,419 137,577 110,227 1,124,431 $ 41,089 399,226 19,581 138,406 160,897 98,713 857,912 $ 57,690 386,869 23,902 208,668 128,474 66,111 871,714 $ 30,743 219,610 29,782 147,350 120,023 43,784 591,292 $ 30,820 305,501 43,667 64,562 198,431 52,087 695,068 1.46% 16.96% 0.60% 5.60% 3.87% 3.10% 31.59% 1.46% 14.21% 0.70% 4.93% 5.73% 3.51% 30.54% 2.28% 15.33% 0.95% 8.27% 5.09% 2.62% 34.54% 1.71% 12.28% 1.66% 8.24% 6.71% 2.45% 33.05% 1.83% 18.09% 2.59% 3.82% 11.75% 3.08% 41.16% Long Term Liabilities: LT Debt (Net-Current Portion) Total LT Liabilities Total Liabilities 613,486 613,486 1,737,917 379,320 379,320 1,237,232 331,741 331,741 1,203,455 183,217 183,217 774,509 289,457 289,457 984,525 17.24% 17.24% 48.83% 13.50% 13.50% 44.04% 13.15% 13.15% 47.69% 10.24% 10.24% 43.29% 17.14% 17.14% 58.30% 10,000 14,976 1,796,279 1,821,255 10,000 14,976 1,546,974 1,571,950 10,000 14,976 1,295,049 1,320,025 10,000 14,976 989,280 1,014,256 10,000 14,976 679,278 704,254 0.28% 0.42% 50.47% 51.17% 0.36% 0.53% 55.07% 55.96% 0.40% 0.59% 51.32% 52.31% 0.56% 0.84% 55.31% 56.71% 0.59% 0.89% 40.22% 41.70% 3,559,172 $ 2,809,182 $ 2,523,480 $ 1,788,765 $ 1,688,779 100.00% 100.00% 100.00% 100.00% 100.00% Stockholders' Equity: Common Stock Additional Paid-In Capital Retained Earnings Total Shareholders' Equity Total Liab & Shareholders' Equity $ '1 \\ Awesome Unadjusted Income Statement Percentage of Sales ,'Jf 2014 2010 Net Sales Cost of Sales Gross Profit Operating Expenses Salaries and Wages: Officers' Compensation } Retail Sales Salaries Managerial Salaries Other Salaries and Wages Total Selling Expenses: Travel & Entertainment Auto Insurance - :;. Telephone Advertising & Promotion Market Research Other , Total General & Administrative : Legal & Accounting Taxes Insurance Office Supplies Donations Postage & Freight Rent Other Total Total Operating Expenses Operating EBITDA (1) Depreciation & Amortization Operating Inc (Loss) EBIT (2) Miscellaneous {Inc) Exp Interest Expense 2013 2012 2014 2011 $ 9,732,602 $ 8,689,823 $ 8,276,022 $ 7,523,657 $ 6,269,714 5,433,308 4,683,767 4,367,529 3,994,185 3,411 ,351 4,299,294 4,006,056 3,908,493 3,529,472 2,858,363 535,4 00 815,8 49 243,3 15 72,9 94 1,667,558 471,90 0 817,8 73 217,24 6 65, 173 1,572,192 15.69% 418,8 00 784,9 01 206,9 01 62,0 70 375,5 00 553,9 00 188,0 91 56,4 28 1,472,672 100.00 % 55.83 % 44.17 % 100.00 % 53.90 % 46.10 % 100.00 % 52.77 % 47.23 % 100.00 % 53.09 % 46.91 % 100.00% 54.41% 45.59% 5.50 % 8.38 % 2.50 % 0.75 % 5.43 % 9.41 % 2.50 % 0.75 % 5.06 % 9.48 % 2.50 % 0.75 % 4.99 % 7.36 % 2.50 % 0.75 % 5.49% 6.95% 983,765 17.13% 18.09% 17.79% 145,9 89 79,2 87 109,77 8 68,7 25 505,98 4 24,33 2 73,0 17 1,007, 112 130,3 47 72,08 0 105,6 62 61,55 7 425,6 26 21 , 725 118,9 85 935,98 2 124,1 40 63,8 99 98,6 98 49,65 7 423,59 2 20,69 0 68,6 65 849,34 1 112.85 5 58,99 7 91 , 834 45,76 8 431,14 9 18,8 09 36,04 0 795,45 2 94,0 46 47,5 40 81,4 65 40,99 1 415, 138 15,6 74 15,4 65 710,3 19 1.50 % 0.81 % 1.13 % 0.71 % 5.20 % 0.25 % 0.75 % 10.35 % 1.50 % 0.83 % 1.22 % 0.71 % 4.90 % 0.25 % 1.37 % 10.78 % 1.50 % 0.77 % 1.19 % 0.60 % 5.12 % 0.25 % 0.83 % 10.26 % 1.50 % 0.78 % 1.22 % 0.61 % 5.73 % 0.25 % 0.48 % 10.57 % 41 , 760 68,15 4 103,9 89 58,71 1 11,70 0 12,5 39 679,1 29 7,50 4 983,48 6 3,658,15 6 57,71 9 73,29 6 106,3 03 44,04 1 9,5 00 8,5 52 582,8 58 12,02 6 894,29 5 3,402,46 9 55,2 29 72,43 1 95,7 89 57,90 4 8,90 0 9,4 55 562,3 52 4, 094 866,15 4 3, 188,167 26,39 8 38,98 1 68,37 6 29,55 1 3,20 0 4,91 7 491, 163 14,7 55 677,34 1 2,646,71 2 37,4 12 42,9 08 56,5 54 28,48 2 3,9 00 9,3 76 418,5 15 9,4 68 606,6 15 2,300,6 99 0.43 % 0.70 % 1.07 % 0.60 % 0.12 % 0.13 % 6.98 % 0.08 % 10.11 % 37.59 % 0.66 % 0.84 % 1.22 % 0.51 % 0.11 % 0.10 % 6.71 % 0.14 % 10.29 % 39.16 % 0.67 % 0.88 % 1.16 % 0.70 % 0.11 % 0.11 % 6.79 % 0.05 % 10.47 % 38.52 % 0.35 % 0.52 % 0.91 % 0.39 % 0.04 % 0.07 % 6.53 % 0.20 % 9.01 % 35.18 % 603,5 87 172,4 66 431 , 121 3,8 47 61,4 70 720,3 26 158,5 38 561,7 88 19,3 67 65,7 91 882,7 60 132,9 80 749,7 80 23,0 71 39,7 44 557,6 64 110,6 80 446,9 84 20,9 55 42,3 32 6.58 % 2.12 % 4.46 % 0.13 % 0.98 % 6.94 % 1.98 % 8.71 % 1.92 % 4.96 % 0.04 % 0.71 % 11.73 % 1.77 % 6.79 % 0.23 % 0.79 % 641,1 38 206,3 33 434,80 5 (12,52 1) 95,1 73 1\\ - 344,0 00 436,0 00 156,7 43 47,0 22 1, 173,919 2013 2.50% 0.75% ' "' 15.60% 1.50% 0.76% 1.30% 0.65% 6.62% 0.25% 0.25% 11.33% '' ' 0.60% 0.68% 0.90% 0.45% 0.06% 0.15% 6.68% 0.15% 9.67% 36.69% 8.90% 1.77% 9.96% 0.31% 0.53% ... 7.13% Income (Loss) Before Taxes Income Taxes Net Income (Loss) Retained Earnings - Beg of Yr Dividends Other Adjustments 0.33% 352, 153 166,2 04 0.68% 365,8 04 167,9 51 476,6 30 203,8 46 686,9 65 296,8 98 185,9 49 1,546,9 74 197,8 53 1,295,0 49 272,7 84 989,2 80 390,06 199,715 479,563 ' 7 679,27 8 (10 0) 63, 356 54,072 32,985 383,6 97 183,9 82 3.61 % 1.71 % 1.90 4.21 % 1.93 % 5.77 % 2.46 % 2.28 9.12 % 3.95 % 3.31 6.12% 2.93% 5.17 3.19 79,965 .... 1. I Retained Earnings - End of Yr $ 1,796,279 $1,546,974 $1,295,049 $ 989,280 $ 679,278 (1) Operating EBITDA = Operating Earnings, before Interest, Taxes, Depreciation & Amortization. " (2) Operating Income (Loss) = Operating Income (Loss) Earnings Before Interest and Taxes