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On January 1, 2016, the Mason Manufacturing Company began construction of a building to be used as its office headquarters. The building was completed on September 30, 2017.
Expenditures on the project were as follows:

January 1, 2016 $ 1,350,000
March 1, 2016 1,080,000
June 30, 2016 1,280,000
October 1, 2016 1,080,000
January 31, 2017 342,000
April 30, 2017 675,000
August 31, 2017 972,000

On January 1, 2016, the company obtained a $3,800,000 construction loan with a 15% interest rate. The loan was outstanding all of 2016 and 2017. The company’s other interest-bearing debt included two long-term notes of $4,000,000 and $6,000,000 with interest rates of 8% and 10%, respectively. Both notes were outstanding during all of 2016 and 2017. Interest is paid annually on all debt. The company’s fiscal year-end is December 31.
Required:
1.

Calculate the amount of interest that Mason should capitalize in 2016 and 2017 using the specific interest method.


2.

What is the total cost of the building?


3.

Calculate the amount of interest expense that will appear in the 2016 and 2017 income statements.

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Hubert Koch
Hubert KochLv2
28 Sep 2019

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Q.

After the financial analysis based on 2016 preliminary estimates was completed, a number of changes were adopted to improve financial and business results for S&S Air during 2016. The customer that awarded the large 40 aircraft order agreed to make interim payments as finished aircraft were delivered (for a price concession). Revenue was revised up slightly due to updated marketing plans. Expenses were trimmed and controls were established that greatly reduced on hand inventory needs. A portion of the line of credit was converted to a 5 year, fixed rate loan. Cash on hand and general liquidity was forecasted to improve to acceptable levels by the end of the year.

Mark and Marie approached Chris about creating a forecast for 2017. They had learned the value of the financial analysis done for 2016 and wanted to get a look at any issues or problems that might be looming in the future. Of particular concern was the continuing need for external funds as the firm continued to grow. The general consensus of Mark and Marie was that S&S Air should realize an increase in revenue of 17% in 2017 from the 2016 results, based on anticipated demand of aircraft. It was felt expenses would change by the same percent of sales as incurred in 2016. However, it was estimated that annual depreciation in 2017 would increase 70% (to a total of $1,075,000), due to the substantial increase in assets that were going to be needed. Finally, Chris said that her banking contract indicted that interest expense should be about 8% of both notes payable and long term debt in 2017.

By the end of 2016, the firm would be operating at capacity; it was estimated that further growth in 2017 would require $6,500,000 (including all depreciation – that is, adding $6.5 million to the 2016 Net PP&E to derive PP&E for 2017) in plant upgrades and additions to meet anticipated production volume. Everyone felt that all other asset categories (including cash) and current liabilities (including the line of credit) would change by percent of revenue. Both owners were concerned about where any needed external financing would come from. Neither was interested in raising any further equity, and agreed that they would likely secure long term financing for any external funds needed. The plan was to pay dividends totaling $400,000 in 2017.

Chris knew that a key exhibit would be the forecast mode. She planned to set up the model so that a key input would be the sales growth forecast. The “plug” to reconcile the balance sheet would be long term debt.

Q U E S T I O N S (please use full sentences)

1) Completed forecast model. Fill in all blanks for the 2017 and 2017 % of rev columns.

2) Compare PM, ROA, and ROE from 2016 to 2017. Why the differences?

3) Compare debt ratios from 2016 to 2017. Why the differences?

4) Compare total asset turnover from 2016 to 2017. Why the difference? What observations can you make regarding capacity utilization from 2016 to 2017?

5) Estimate the maximum revenue possible given the new level of assets in 2017, based on TATO in 2016 (at full capacity).

6) If COGS could be decreased by 1% of revenue, how much increase in EBIT would result? Express the change in EBIT in both dollar terms and % change.

7) Do a DuPont analysis on S&S Air for both 2016 and 2017. If the owners asked you for any issues or concerns about the basic results forecasted for 2017, what would you tell them? Consider operating, investing, and financing issues.

7a) Operating comments:

7b) Investing comments:

7c) Financing comments:

Income statement 2016 % rev 2017 % rev
Sales $21,566,000 100.0% 17%%
COGS 14,786,000 68.6% % of rev 68.6%
Other expenses 2,375,000 11.0% % of rev 11.0%
Depreciation 625,000 2.9% given 1,075,000
EBIT 3,780,000 17.5% calc
Interest 437,000 2.0% given 8.0%
Taxable income 3,343,000 15.5% calc
Taxes (40%) 1,337,200 6.2% calc TI * tax rate 40.0%
Net income 2,005,800 9.3% calc
Dividends 375,000 1.7% given 400,000
Add to RE 1,630,800 7.6% calc
B A L A N C E S H E E T
2016 % rev 2017 %
Current Assets
Cash 425,000 2.0% % of rev 2.0%
Accounts rec. 855,000 4.0% % of rev 4.0%
Inventory 689,000 3.2% % of rev 3.2%
Total CA 1,969,000 9.1% calc
Fixed assets
Net PP&E 9,873,000 45.8% given 6,500,000
Total Assets 11,842,000 54.9% calc
Current Liabilities
Accounts Payable 727,000 3.4% % of rev 3.4%
Notes Payable 1,467,000 6.8% % of rev 6.8%
Total CL 2,194,000 10.2% calc
Long-term debt 2,908,800 13.5% PLUG
TOTAL CL + LTL 5,102,800
Shareholder Equity
Common stock 120,000 0.6% no change
Retained earnings 6,619,200 30.7% +2017 RE
Total Equity 6,739,200 31.2% calc
Total L&E 11,842,000 54.9% calc
Ratio Analysis
2016 2017
PM
ROA
ROE
Debt / Equity
Debt / Total Assets
Equity Multiplier
Total Asset TO

Thank you

Dessin Company is constructing a building. Construction began on January 1, 2012 and was completed on December 31, 2012. Expenditures were

March 1, 2012

$750,000

June 1, 2012

200,000

September 31, 2012

350,000

October 1, 2012

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December 31, 2012

250,000

Company borrowed $1,300,000 on January 1 on a 7-year, 11% note to help finance construction of the building. In addition, the company had outstanding all year a 12%, 4-year, $2,800,000 note payable and an 10%, 4-year, $3,400,000 note payable.

What are the weighted-average accumulated expenditures?

What is the weighted-average interest rate used for interest capitalization purposes?

What is the avoidable interest for the company?

What is the actual int bzscerest for the company?

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MINI CASE: OMEGA PRODUCTS COMPANY The Omega Products Company is a successful small, rapidly growing, closely held corporation. The equity owners are considering selling the firm to an outside buyer and want to estimate the value of the firm. Last year’s income statement (2016) can be found on the related spreadsheet. Sales are expected to grow at an annual percentage rates of 20%, 15%, 10%, 5% & 3% beginning in 2017 and continuing thereafter. Selected balance sheet accounts at the end of 2016 were as follows. Net fixed assets were $50,000. The sum of the required cash, accounts receivable, and inventories accounts was $50,000. Accounts payable and accruals totaled $25,000. Each of these balance sheet accounts was expected to grow with sales over time. No changes in interest-bearing debt were projected and there were no plans to issue additional shares of common stock. There are currently 10,000 shares of common stock outstanding. Data have been gathered for a “comparable” publicly-traded firm in the same industry that Omega’s operates in. The cost of common equity for this other firm, ALPHA Products, was estimated to be 25 percent. Omega has survived for a period of years. Management is not currently contemplating a major financial structure change and believes a single discount rate is appropriate for discounting all cash flows. SHOW ALL WORK IN AN EXCEL SPREADHSHEET

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C. Project annual operating free cash flows for the years 2017 to 2021. The annual operating free cash flow to equity is calculated as: net income + depreciation – CAPEX – increases in required NWC + increases in interest-bearing debt. Note: No changes in interest-bearing debt were projected and there were no plans to issue additional shares of common stock.

D. Estimate Omega’s terminal value cash flow at the end of 2020.

E. Estimate Omega’s equity value in dollars and per share at the end of 2016.

F. Omega’s management was wondering what the firm’s equity value (dollar amount and on a per share basis) would be if the cost of equity capital was only 20 percent. Recalculate the firm’s value using this lower discount rate (also, as of the end of 2016).

G. Now assume that the $35,000 in long-term debt (and therefore interest expense at 10%) is expected to grow with sales. Recalculate the equity using the original 25% discount rate (use the second spreadsheet for part G).

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