Lavinia Products plc manufactures toys and other goods for children. It has been trading for 3 years. Five people own the shares in the company, all of them employed full time in the business. The entity is doing well and now needs additional capital to expand operations. Assume that you are a consultant working for Lavinia Products plc. You have been assigned to the entity to advise on its objectives and financial situation. As well as being provided with financial statements for the year to 31 December 2016, the entity’s accountant gives you the following information:

A summary of the financial statements for the year to 31 December 2016 is shown below.

LAVINIA PRODUCTS PLC

Summarised income statement for the year to 31 December 2016                             £’000

Revenue                                                                                                                         1,560

Cost of sales                                                                                                                   (950)

Gross profit                                                                                                                      610

Operating expenses                                                                                                        (325)

Interest                                                                                                                             (30)

Tax liability                                                                                                                     (84)

Net profit                                                                                                                          171

Dividends declared                                                                                                            68

Summarised balance sheet at 31 December 2016

£’000

Non-current assets (net book value)                                                                                 750

Current assets

Inventory                                                                                                                           326

Receivables                                                                                                                       192

Cash and bank                                                                                                                     50

               1,318

£’000

Capital and reserves

Ordinary share capital (ordinary shares of £1)                                                    500

Retained profits to 31 December 2015                                                                128

Retentions for the year to 31 December 2016                                                     103

Total financing                                                                                                               731

Non-current liabilities

10% debenture redeemable 2020                                                                         300

Current liabilities

Accounts payable                                                                                                 135

Other payables (including tax and dividends)                                                     152

                                                                                                                                                    

   1,318

Requirements

Using the information in the case:

(a) Prepare forecast income statements for the years 2017, 2018 and 2019, and calculate whether the entity is likely to meet its stated financial objective (return on shareholders ’ funds) for these 3 years.                                                                                      

Notes:

1. You should ignore interest or returns on surplus funds invested during the 3-year period of review.

2. This is not an investment appraisal exercise; you may ignore the timing of cash flows within each year and you should not discount the cash flows.

3. Ignore inflation.