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Please help me find the solution for Chapter 4 Mini Case: Hobby Horse Company" Page 113 in the Fundamentals of Corporate Finance 8th edition Brealey, Myers, Marcus; McGraw Hill, Irwin Thank you.

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Page 1
Chapter 4: Measuring Corporate Performance
Case Study: Corporate Lending Group: The Hobby Horse
Company, Inc. (HH)
Burchetts Green had enjoyed the bank training course, but it was good to
be starting his first real job in the corporate lending group. Earlier that
morning the boss had handed him a set of financial statements for The
Hobby Horse Company, Inc. (HH). "Hobby Horse," she said, "has a $45
million loan from us due at the end of September, and it is likely to ask us
to roll it over. The company seems to have run into some rough weather
recently, and I have asked Furze Platt to go down there this afternoon and
see what is happening. It might do you good to go along with her. Before
you go, take a look at these financial statements and see what you think
the problems are. Here's a chance for you to use some of that stuff they
taught you in the training course."
Mr. Green was familiar with the HH story. Founded in 1990, it had rapidly
built up a chain of discount stores selling materials for crafts and hobbies.
However, last year a number of new store openings coinciding with a poor
Christmas season had pushed the company into loss. Management had
halted all new construction and put 15 of its existing stores up for sale.
Mr. Green decided to start with the 6-year summary of HH's balance sheet
and income statement (Table 4-1). Then he turned to examine in more
detail the latest position (Tables 4-2 and 4-3).
Source: Brealey, R.A.; Myers, S.C.; Marcus, A.J. (2009): Fundamentals of
Corporate Finance, 6th ed., New York: McGraw Hill, p. 107.
Questions:
What appear to be the problem areas in HH? Do the financial ratios
suggest questions that Ms. Platt and Mr. Green need to address?
1. Calculate financial ratios to interpret HH’s profitability, efficiency,
leverage, and liquidity. Use flow measures for the calculation of the
profitability and efficiency ratios (averages of the year).
2. For the preparation of the meeting with the bank, calculate also the
development of the leverage and liquidity ratios over the past years.
3. Interpret the calculated ratios and give suggestions for the management
how to proceed or how to (possibly) solve the problems.
Fachbereich Elektrische
Energietechnik
Prof. Dr. Valerie Wulfhorst
Betriebswirtschaftslehre,
insb. Controlling
Telefon
02921 378-451
Telefax
02921 378-409
E-Mail
[email protected]
Standort Soest
Lübecker Ring 2
59494 Soest
Fachhochschule
Südwestfalen
Sitz: Iserlohn
Hagen
Iserlohn
Meschede
Soest
www.fh-swf.de
Page 2
Tables:
Table 4- 1: Finance highlights for The Hobby Horse Company, Inc., year
ending March 31
Table 4- 2:
2008 2007 2006 2005 2004 2003
Net sales 3,351 3,314 2,845 2,796 2,493 2,160
EBIT -9 312 256 243 212 156
Interest 37 63 65 58 48 46
Taxes 3 60 46 43 39 34
Net profit -49 189 145 142 125 76
Earning per share -0.15 0.55 0.44 0.42 0.37 0.25
Current assets 669 469 491 435 392 423
Net fixed assets 923 780 753 680 610 536
Total assets 1,592 1,249 1,244 1,115 1,002 595
Current liabilities 680 365 348 302 276 320
Long-term debt 236 159 297 311 319 315
Stockholder’s equity 676 725 599 502 407 324
Number of stores 240 221 211 184 170 157
Employees 13,057 11,835 9,810 9,790 9,075 7,825
INCOME STATEMENT FOR
THE HOBBY HORSE COMPANY, INC.,
FOR YEAR ENDING MARCH 31, 2008
(all items in millions of dollars)
Net sales 3,351
Cost of goods sold 1,990
Selling, general, and administrative expenses 1,211
Depreciation expense 159
Earnings before interest and taxes (EBIT) -9
Net interest expense 37
Taxable income -46
Income taxes 3
Net income -49
Allocation of net income
Addition to retained earnings -49
Dividends 0
Page 3
Table 4- 3:
CONSOLIDATED BALANCE SHEET FOR THE HOBBY HORSE COMPANY, INC.
(figures in millions of dollars)
Assets Mar. 31, 2008 Mar. 31, 2007
Current assets
Cash and marketable securities 14 72
Receivables 176 194
Inventories 479 203
Total current assets 669 469
Fixed assets
Property, plant, and equipment (net of depreciation) 1,077 910
Less accumulated depreciation 154 130
Net fixed assets 923 780
Total assets 1,592 1,249
Liabilities and Shareholders' Equity Mar. 31, 2008 Mar. 31, 2007
Current liabilities
Debt due for repayment 484 222
Accounts payable 94 58
Other current liabilities 102 85
Total current liabilities 680 365
Long-term debt 236 159
Stockholders' equity
Common stock and other paid-in capital 155 155
Retained earnings 521 570
Total stockholders' equity 676 725
Total liabilities and stockholders' equity 1,592 1,249

Garnett Jackson, the founder and CEO of Tech Tune-Ups, stared t the window as he finished his customary peanut butter and jelly dwich, contemplating the dilemma currently facing his firm. ech Tune-Ups is a start-up firm, offering a wide range of com- ter services to its clients, including online technical assistance, ote maintenance and backup of client computers through the temet, and virus prevention and recovery. The firm has been 'ghly successful in the 2 years since it was founded; its reputation fair pricing and good service is spreading, and Mr. Jackson lieves the firm is in a good position to expand its customer base idly. But he is not sure that the firm has the financing in place to rt that rapid growth. Tech Tune-Ups' main capital investments are its own powerful mputers, and its major operating expense is salary for its consul- ts. To a reasonably good approximation, both of these factors w in proportion to the number of clients the firm serves. Currently, the firm is a privately held corporation. Mr. Jackson his partners, two classmates from his undergraduate days, have tributed $250,000 in equity capital, largely raised from their nts and other family members. The firm has a line of credit a bank that allows it to borrow up to $400,000 at an interest of 8%. So far, the firm has used $200,000 of its credit line. If when the firm reaches its borrowing limit, it will need to raise ity capital and will probably seek funding from a venture capi- firm. The firm is growing rapidly, requiring continual invest- t in additional computers, and Mr. Jackson is concerned that it approaching its borrowing limit faster than anticipated. 525 Mr. Jackson thumbs through past financial statements and esti- mates that each of the firm's computers, costing $10,000, can sup- port revenues of $80,000 per year but that the salary and benefits paid to each consultant using one of the computers is $70,000. Sales revenue in 2011 was $1.2 million, and sales are expected to grow at a 20% annual rate in the next few years. The firm pays taxes at a rate of 35%. Its customers pay their bills with an average delay of 3 months, so accounts receivable at any time are usually around 25% of that year's sales. Mr. Jackson and his co-owners receive minimal formal salary from the firm, instead taking 70% of profits as a "dividend," which accounts for a substantial portion of their personal incomes. The remainder of the profits are reinvested in the firm. If reinvested profits are not suffi- cient to support new purchases of computers, the firm borrows the required additional funds using its line of credit with the bank. Mr. Jackson doesn't think Tech Tune-Ups can raise venture funding until after 2013. He decides to develop a financial plan to determine whether the firm can sustain its growth plans using its line of credit and reinvested earnings until then. If not, he and his partners will have to consider scaling back their hoped-for rate of growth, negotiate with their bankers to increase the line of credit, or consider taking a smaller share of profits out of the firm until further financing can be arranged. Mr. Jackson wiped the last piece of jelly from the keyboard and settled down to work. Can you help Mr. Jackson develop a financial plan? Do you think his growth plan is feasible? Prepare a 700-1,050 word response, plus Excel spreadsheet, for the Mini-case at the end of Chapter 18 in Fundamentals of Corporate Finance (Brealey). Specifically, the Learning Team will need to follow all assumptions in the Mini-case precisely and carefully to complete the following: a. Identify the steps necessary to financially plan and forecast for 2005, 2006, and 2007, b. Project future years using the growth rate assumptions in the Mini-case, c. Determine what type and amount of financing may be required, taking into account the impact on leverage ratios, d. Determine the impact of rising interest rates on future performance, e. Assess alternative capital structures and impact on debt ratio and return on equity. f. Separately, after completing (a) through (e) above, explain how outsourcing certain cost of goods sold items would impact this planning and budgeting process.

Hey guys, could you please helpwith the below case study.

1. The cash flows at thestart.

2. The cash flows over thelife.

3. The cash flows at theend.

4. What is the NPV of theproposed Engadine store, and your recommendation?

1. Michael Hill InternationalLimited (hereafter known as “Michael Hill”) ordinary

shares are listed on theAustralian Securities Exchange (ASX). Michael Hill ownsand

operates approximately 300retail jewellery stores across Australia, New Zealandand

Canada. According to the ASXannouncement made by Michael Hill on Date: 27/08/18 and

Headline: InvestorPresentation, part of Michael Hill’s planned capital expenditure of$25

million is to open new stores.Michael Hill has already performed a substantial amountof

data analysis related to oneparticular planned new store in the southern Sydney suburbof

Engadine. However, the capitalexpenditure associated with the construction of a newstore

and the operating expenses aresubstantial. Therefore, before Michael Hill commits to

building the newstorea financialanalysis is needed to determine if it will contribute tothe

goal of creating wealth for itsshareholders.

2. You are employed in MichaelHill’s corporate finance department and have impressed

senior management with youraptitude for financial analysis. This talent wasdeveloped

through the practice-orientedassignments that you completed at University. You recallhow

exciting it was learning aboutlisted companies by searching and reading announcements

made to the ASX. The ChiefFinancial Officer (CFO) has asked you to perform afinancial

analysis of the plannedEngadine store using a purpose-built preformatted EXCEL

spreadsheet. The CFO hassuggested you liaise with company employees from a varietyof

different departments tocollect the information that is necessary to perform the analysis.You

will also search through publicdocuments to identify some of the assumptions that willbe

required in your financialanalysis, and certain additional information. Your analysis willbe

provided to the Board ofDirectors who must approve substantial capitalexpenditures.

3. The two major cash outflowsassociated with a new store are the cost of the building

and the fixtures and fittingssuch as specialised jewellers’ equipment and displaycabinets.

The directors are accountableto the shareholders and so a financial analysis is necessaryto

be confident that theinvestment in the new Engadine store is justified. Thefollowing

paragraphs contain asubstantial amount of information that has been gathered fromacross

the business and it is your jobto determine which information is relevant to theanalysis.

4. The capital cost of theEngadine building is expected to be $2.3 million today.

Michael Hill has $7.2 millioncash and it plans to use $1.6 million of this amount to payfor

the building which will reducethe cost to just $700,000. If the new store is built,some

redundant jewellery equipmentmust be sold. The equipment had a total capital cost in2016

of $600,000 and for taxpurposes have a ten-year life. The equipment can be sold todayfor

$130,000 and Michael Hill willuse the sale proceeds to distribute a $130,000 dividend toits

shareholders today.

5. According to the InvestorPresentation Michael Hill recently completed a

comprehensive brand review torespond to a changing consumer landscape. This reviewcost

$375,000 and there is debateamong management about whether the cost of this review

should be classified as atax-deductible expense in the financial analysis.

6. The annual sales for a newstore are difficult to predict. However, Michael Hill is

confident that the Engadinestore can achieve sales in the first year of operation thatare

similar to an ‘average’ MichaelHill Australian store. You read the Investor Presentationto

identify the following twofigures relevant to MICHAEL HILL AUSTRALIA for the year

ending Jun-18:

a) Revenue

b) Total stores open

You use these two figures tocalculate an average revenue figure per store for 2018.

7. Since Michael Hill plans tobuild the new store in the year 2019, for capitalbudgeting

purposes the first year ofrevenue is expected in 2020. However, the retail environmentis

very challenging as evidencedby the disappointing Australian same-store sales growthrate

stated in the InvestorPresentation. Therefore, you forecast that the Engadinestore’s

revenue in 2020 is equal to theaverage revenue figure per store for 2018 that youcalculated

in Paragraph 6 compounded bythe same-store sales growth rate. Beyond 2020 revenue is

forecast to increase by 2% p.a.reflecting the benefits of the brand review.

8. The Investor Presentationstates the business has gross profit margins of

approximately 63%. Therefore,your analysis assumes that costs of goods sold at the

Engadine store are 37% ofrevenue. Fixed costs at the Engadine store in 2020 are$240,000.

Management is confident thatwith rigorous cost control they will be able to containthe

increase in fixed costs to 2%p.a. for each subsequent year. If the Engadine store isbuilt,

Michael Hill anticipates thattotal cash operating expenses will equal 26% of sales.

9. Starting in 2020, employeesat the Engadine store will receive annual training.

Michael Hill performs alltraining in-house using a dedicated facility that was establishedin

2017. The facility has anannual budget of $655,000 and inducts new employees in allaspects

of the jewellery business.Ordinarily, Michael Hill would charge an arms-length amountof

$75,000 per annum for stafftraining. However, the training division has sufficientspare

capacity to train the Engadinestore’s employees without the facility incurring anyadditional

costs. The accounts departmentrecommends internally invoicing the $75,000 training

expense to the Engadine storeeach year.

10. For taxation purposes thenew building has a twenty-year life. However, MichaelHill

will perform the financialanalysis of the Engadine store over a ten-year period. Thenew

store requires $300,000 ofdisplay cabinets. The Australian Taxation Office (ATO)confirms

that display cabinets have aneight-year tax life. In Michael Hill’s experience,display

cabinets be operatedeffectively for a full ten years before they need replacing.Michael Hill’s

management accountantsdepreciate all assets over an operational six-year life.

11. Michael Hill’s Research& Development department has spent $130,000 inrecent

years developing a wedding ringsizing app. This project is still several years away fromfullscalerelease but toensure this expense generates the required returns the directorswant to

include it in the analysis ofthe Engadine store as a cash outflow in 2019.

12. Michael Hill will borrow$1.2 million today to finance the Engadine store. Thetenyearinterest-only loanhas annual interest repayments of $48,000 (assuming a 4% p.a.rate).

Michael Hill’s accountantconfirms that interest payments are classified as a businessexpense

and are therefore taxdeductible.

13. To promote the new Engadinestore the marketing department has budgeted $85,000

of advertising for the store’sopening in 2020. Because this expense will reduce thenew

store’s profitability in 2020,managers have suggested that the advertising expense bespread

out over the new store’sten-year useful life. The ATO states that expenses associatedwith

the Engadine store’s grandopening can be claimed as a business expense in the yearincurred.

Michael Hill’s totaladvertising budget for 2020 is $3.4 million and predicted toincrease by

$200,000 each year. If theEngadine store opens, the annual advertising budget willremain

unchanged. For cost accountingpurposes Michael Hill must allocate overheads acrosseach

business unit. Therefore, it isproposed that the Engadine store be assigned a fraction of1/171

of the total advertisingbudget.

14. Michael Hill assumes thatthe Engadine building can be sold for $400,000 in theyear

2029. At any point in time theresale value of the display cabinets is just $26,000. Inten

years’ time Michael Hillassumes that it will have cash holdings of $4.4 million. You notethe

ATO regulation that allnon-current assets be depreciated to zero.

15.If the Engadine store proceeds, then Michael Hill will implement aprivate placement

to raise $800,000 frominstitutional investors to fund the store. The CEO’s annual salaryin

2018 is $1,511,738 and is notexpected to change whether the Engadine store opens ornot.

16.If the directorsapprove the Engadine store Michael Hill anticipates that it willrequire

an additional $400,000 ofinventory today on top of the existing level of $1.5 million,and

accounts payable will increaseby $270,000. The accounts receivable balance willincrease

from the current level of $5.4million to $6.2 million if the Engadine store proceeds.

17.Michael Hill has arequired rate of return of 9%. Assume the company tax ratewill

remain at 30%.

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