Introduction
The Bank will consider both the financial status of Custom Snowboards and the project for which the funds are being borrowed. An analysis of these factors is presented in the subsequent slides.
Four major financial ratios are considered over the past two years. The current ratio indicates the company’s liquidity while the debt ratio indicates the company’s leverage. Net sales indicate the company’s growth prospects while operating profit margin indicates its overall profitability.
Custom Snowboards is financially stable in the short run. The current ratio in Y13 is 6.82, while Y14 is 5.84. The company’s current assets can cover current liabilities over five times. Custom Snowboards are highly geared. The company financed over 50% of its operations using debt in both Y-13 and Y 14. This may be a point of concern for the bank manager. The Net Operating Margin is another point of concern. It is has reduced in half from 3.5 to 1.5 in Y14.
The company plans to sell 43878 units. At this level and with the planned costs, the company will make an operating profit of 330,364. However, if the company sells fewer units and the operating expenses rise, the contribution margin will decrease. The fixed costs cannot be changed. Therefore, if the actual output is as projected, then the company will incur an operating loss of 25,665. This is because the BEP will rise to 43,082 units. This variance may be another point of concern for the bank loan officer.
In order to counter the leverage risk, the company could opt for part equity and part debt financing for the European expansion. The company’s Times Interest Earned and Net Profit Margins can be improved by instituting strict cost control measures and adopting a new method of costing such as ABC or Kaizen. Custom Snowboard could re-negotiate the terms of its mortgage repayment to spread the payments further out.
Ratio Analysis
The company’s leverage shows the effect of interest on the company. Over the years 12-14, Custom Snowboard’s leverage has been increasing, from 1.47, 1.52 to 1.70. If the bank authorizes the loan, the leverage will increase due to the additional interest expense. Higher leverage means a higher risk of loan default.
The time’s interest earned indicates how many times the company can cover its interest payments using its profits. Custom Snowboard’s Times Interest Earned has been increasing slightly over the years. The company can now comfortably cover its interest payments almost three times. The new interest will increase the interest expense by almost 90%. This is a major area of concern for the bank.
Custom Snowboards has a large mortgage balance. Currently, approximately 39% of assets are financed by a mortgage. The bank may be concerned that the mortgage repayments and new loan repayments may overburden the company.
Presentation to the CEO
Financial Analysis
Financial Performance is assessed using two methods. They are Horizontal and Ratio analyses. Horizontal Analysis compares company performance throughout study. Custom Snowboards Inc’s performance over the past two years is shown in this slide. Net Sales and Selling expenses decreased in year 14 as compared to Y13. This can be explained by the decrease in overall demand for Snowboards. However, the company managed to improve its net earnings. Current liabilities also decreased. The current assets showed the worst performance in Year 14, decreasing by 29.8%. The company could have used the current assets to meet the increase in demand due to the winter Olympics.
20% of the company’s sales have been to Europe. The Sales forecasts for Europe show steady growth for the next five years. These projections have been prepared based on the company’s past sales and expected incremental sales due to expansion. This is an indication of the viability of the investment opportunity
Cost control
Custom Snowboards can create a flexible budget and analyze the contribution margin of various financial amounts from the income statement. Variances in operations can be detected in specific areas of the manufacturing process. A review of the data indicates that the cost of variable overhead differs from the budgeted amount creating an unfavorable overhead efficiency variance.
Additionally, management has been asked to consider implementing activity-based costing (ABC) in its production process. Custom Snowboard Inc can benefit from adopting other current costing methods alongside ABC. Target costing will enable the company to reduce cost of production deliberately while maintaining items that customers value.
Management has been asked to consider implementing activity-based costing (ABC) in its production process. This is highly recommended because ABC can assist in product and pricing mix decisions, reducing costs, improving processes, and other important decisions related to product design. By comparing unit costs using traditional costing processes with that of ABC, traditional cost per unit for a regular board is $119 compared to $105 by implementing an ABC system. The per-unit cost for personalized boards using the traditional costing method is $162 compared to $218 per unit with ABC. Personalized snowboards need numerous setups and inspections and are thus costly.
Personalized boards only account for 20% of the company’s sales whereas regular boards account for the remaining 80% of sales. Analyzing the factors which cause costs to be incurred can be better accomplished using an ABC system. By using this method, the company has the opportunity to improve the way work is done. Management can use information obtained by an ABC system to evaluate whether certain non-value-added activities can be reduced or even eliminated
Available Options
The leasing option is better than buying because it costs less in the end. However, it would mean that the company starts from scratch in Europe. This can be avoided by either acquiring SnowFun or merging with it. These decisions are evaluated below.
European expansion through merger or acquisition of the European company SnowFun, Inc. was also assessed using financial analysis in making this important business decision. Custom Snowboards, Inc. has a current EPS of $0.98. SnowFun, Inc. has a current EPS of $0.27. If Custom Snowboards, Inc. were to merge with SnowFun, Inc., EPS would decrease to $ 0.92. In addition, SnowFun, Inc. has a lower price-earnings ratio at 9 compared to that of Custom Snowboards, Inc. at 20.
An acquisition of SnowFun, Inc. however, would also be beneficial to the company because the offer price of $720,000 is less than the present value of $732,522 providing a net present value of $12,522 for this investment. This is therefore the best option.
Risks
Cultural mismatches are common during acquisitions. For instance, Americans tend to be more liberal and flexible than Europeans. Such differences could lead to sub-optimal performance.
Employees may resist the change. They may have difficulty working with the new team. This can lead to poor performance or the resignation of key personnel. Both companies can lose key talented personnel who do not support the move. These talented individuals could leave and opt to work for competitors.
Shareholder value may be destroyed by this acquisition. This may happen if the two companies’ combined inefficiencies are more than the efficiencies. Reduced shareholder value will be evident in reduced EPS.
Acquisition may enhance the weaknesses of the two companies hence giving competitors leverage. This can lead to losses and market share reduction. This would be detrimental to the new company as profitability would be affected negatively.
Customers may also react negatively to the new change. They may reject the new outfit and opt to buy from competitors instead. This can happen especially for loyal Custom Snowboards customers. They may perceive the products as being from SnowFun Inc rather than Custom Snowboards.
The company’s reputation could suffer. Custom Snowboards is known for making the most durable snowboards in the market. This merger may be seen as having a negative impact on its product quality. Poor reputation may result in reduced sales in Europe.
The expanded European operations expose Custom Snowboards to increased currency risk. The company’s financials are translated to American currency. If the European operations are increased, then more transactions are done in foreign currency. This exposes the company to additional translation risks.
The Situation
To meet the increasing demand for its product in European markets, Custom Snowboards, Inc. considered three separate expansion options for new operations in the market. The options under consideration were building its own facility, merging operations with the European-based company SnowFun, Inc. or instead, acquiring this company. Financial analysis measures including capital budgeting and calculation of specific financial ratios were used in determining the most profitable outcome for the options available. Capital budgeting yielded negative results for the new European plant decision. Calculation of net present value, earnings per share and cash flows projections were used to assess whether expansion by merger or acquisition would be more profitable for the company. While both options produced positive results, additional non-financial factors make European expansion through acquisition more beneficial.
Management must choose the financing option that maximizes company value and maintains stock value while increasing the shareholder’s return. Custom Snowboards, Inc. has the option of financing this investment for $1,000,000.00 at a rate of 6.75% for five years with a $300,000.00 compensating balance. Another option would be for the company to use a combination of debt and equity to finance the investment at rates of 30% to 70% and 80% to 20% respectively. The final option would be to raise enough equity alone to undertake the investment. By using financial analysis to compare the various capital structures, accepting the bank’s financing terms for the investment would be the most beneficial option for Custom Snowboards, Inc.
Conclusion
In choosing a suitable financing method, managers must consider the effect on shareholders, hence the effect on EPS. The European Expansion presents a great opportunity for Custom Snowboards to grow its revenue and global presence. Given all the financial factors, the best option for financing this expansion is 100% debt.
However, Custom Snowboards needs to consider its ability to maintain the required compensating balance of $300,000. This balance will be tied up at the bank and the company will not be able to use it for investment. Custom Snowboard needs to improve its management of expenses with immediate effect. Failure to do this may lead to financial difficulty shortly.