It is January 3, 2019. You, CPA, operate as a sole practitioner. Jason Yao, the owner of Mac & Master Bakery LTD. (M&M), has approached you for some advice. M&M has operated in the town of Kentville, Nova Scotia for over 40 years. Initially, the company sold its products directly to customers in the local community. Over time, the company expanded and now relies mainly on the sales of baked goods to grocery chains and locally owned convenience stores. As a result, transportation costs have risen directly as a result of the additional sales. Jason is in the middle of negotiations with Loblaws, a large chain of grocery stores. He is wondering whether the contribution margin generated by this potential contract would be positive and whether he should accept the Loblaws deal. Jason is considering acquiring some additional equipment to be paid for and placed in service at the very beginning of 2020 that will increase M&M’s baking capacity by 10% for each of the next three years. M&M’s bank is willing to lend an amount equal to approximately 65% of the cost of the new equipment. In addition, they require the loan to be repaid over three years with annual equal principal repayments starting June 30 plus interest calculated at 5% interest per annum. Jason is worried that M&M will not be able to make the repayments over such a short period of time and has asked you to prepare a cash flow projection for each year the debt is outstanding to support his decision. Jason has asked you to prepare a report that addresses his concerns. In order to assist you, Jason provided you with additional information (Appendix I) and a copy of M&M’s draft financial statements (Appendix II).

APPENDIX I

ADDITIONAL INFORMATION

Loblaws is M&M’s biggest customer, currently generating 35% of its sales. Another large grocery chain, Sobeys, is the company’s next largest with 25%. The remaining 40% of sales is attributable to small convenience store sales. Those sales breakdowns are expected to remain stable for the next few years. If the deal with Loblaws goes through, it would result in a 60% increase in current sales to Loblaws. Unfortunately, the bakery is now operating at full capacity so the increase in sales to Loblaws would have to be offset by a proportional decrease in sales to the small convenience stores. In the absence of the Loblaws deal, M&M’s total revenue and costs in 2019 are expected to remain unchanged from 2018 due to the capacity constraint. The products sold to Loblaws and Sobeys have, on average, direct material and direct labour costs of 47.5% and 10% of the selling price, respectively. On the other hand, products sold in the convenience stores have, on average, direct material and direct labour costs of 55% and 20% of the selling price, respectively. As a result of recent union negotiations, starting in 2020, labour costs for the sales to grocery store chains are expected to increase by 4% per annum for the next three years. The new equipment (CCA class 53) will cost $1 million and have an expected useful life of ten years. Besides the proposed new equipment purchase, no additional property, plant, and equipment acquisitions are expected in the next four years. Starting in 2020, projected CCA deductions for the existing equipment are as follows: $390,000, $330,000, and $270,000. M&M’s long-term debt was renegotiated in July 2018 at a new interest rate of 5% per annum. The balance of $2,250,000 is to be paid off evenly over 10 years, starting June 2020. The general inflation rate is expected to be 2% per annum starting in 2020. M&M is taxed at a total of 15.5% on business income below $500,000 and 26.5% on business income above $500,000.

APPENDIX II DRAFT FINANCIAL STATEMENTS

M&M BAKERY INC. INCOME STATEMENT For the year ended December 31 (unaudited) 2018
Revenue	$ 11,497,500
Cost of sales – raw materials	5,806,200
Cost of sales – labour	1,609,700
7,415,900
Gross profit	4,081,600
Expenses
Advertising and promotion	475,000
Salaries and wages	320,000
Transportation	2,043,100
Telephone and communication	120,000
Professional fees	50,000
Utilities	201,000
Other	77,500
3,286,600
Operating income	795,000
Amortization	450,000
Gain on sale of assets	(160,000)
Interest on long-term debt	115,000
Income before income taxes	390,000
Income tax expense	58,100
Net income	$ 331,900