+ All Categories
Home > Documents > Michaels Custom Woodworking Ltd. 2005 Solution Exam CMA

Michaels Custom Woodworking Ltd. 2005 Solution Exam CMA

Date post: 29-Dec-2015
Category:
Upload: crystal1224
View: 171 times
Download: 2 times
Share this document with a friend
Popular Tags:
26
Michaels Custom Woodworking Ltd. (MCW) Sample Solution A REPORT TO THE PRESIDENT OF MICHAELS CUSTOM WOODWORKING LTD. TABLE OF CONTENTS Executive Summary Introduction Situation Analysis MCW’s Mission Statement Shareholder Preferences Situation Analysis Financial Assessment Strategic Analysis Alternative 1: Sell MCW to Charette Custom Cabinets (CCC) Alternative 2: Accept the proposal from JaCo Alternative 3: Set up a Bordertown plant Alternative 4: Expand or retreat from the transportation segment Alternative 5: Acquire control of Bordeleau Haulage Inc. (BHI) Strategic Recommendations Analysis of Business and Operational Issues A. Financing B. Pricing C. Human Resource Issues D. Management Information Systems E. Financial Accounting F. Buy or Lease Facilities Implementation Plan Conclusion
Transcript

Michaels Custom Woodworking Ltd. (MCW) Sample Solution

A REPORT TO THE PRESIDENT OF MICHAELS CUSTOM WOODWORKING LTD.

TABLE OF CONTENTS Executive Summary Introduction Situation Analysis MCW’s Mission Statement Shareholder Preferences Situation Analysis Financial Assessment Strategic Analysis Alternative 1: Sell MCW to Charette Custom Cabinets (CCC) Alternative 2: Accept the proposal from JaCo Alternative 3: Set up a Bordertown plant Alternative 4: Expand or retreat from the transportation segment Alternative 5: Acquire control of Bordeleau Haulage Inc. (BHI) Strategic Recommendations Analysis of Business and Operational Issues A. Financing B. Pricing C. Human Resource Issues D. Management Information Systems E. Financial Accounting F. Buy or Lease Facilities Implementation Plan Conclusion

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 2

Exhibits Exhibit 1 - SWOT Summary Exhibit 2 - Financial Assessment of MCW Exhibit 3 - Supporting Analysis of the Charette Custom Cabinets Offer Exhibit 4 - Supporting Analysis of the JaCo Proposal Exhibit 5 - Analysis of Pricing Exhibit 6 - A Proposed Organization Chart Exhibit 7 - Implementation Plan

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 1

EXECUTIVE SUMMARY

MCW has been in operation for about six years. In that time, it has built a reputation for quality and price. It has a history of profits and growth, although there was a slight negative reversal in both areas in 2003. Recently, MCW lost its production facility as the result of a fire. The company is well insured so there is not expected to be any significant financial loss from this event, but it has forced a consideration, by the shareholders and, particularly, by the President, Mr. Brook Michaels, of which strategic direction MCW should to pursue at this time. This report examines MCW’s current environment and available strategic options. These options include the possibility of selling the company, accepting a proposal from a Japanese company (JaCo), establishing a plant in Bordertown, U.S.A., and reviewing its participation in the transportation industry. Additionally, the prime shareholders, Brook and Lynn Michaels, have available to them the possibility of taking over Bordeleau Haulage Inc. In the event that MCW is retained by the current shareholders, a decision that is recommended below, there are several operational areas that should be addressed. These include the management information and human resource areas, as well as some marketing, management and financial accounting issues. In particular, pricing and administrative support are areas requiring immediate attention. The recommended strategy is to reject the purchase offer from CCC and to accept the proposal from JaCo. It is further recommended that MCW not take any other expansionary steps at this time, and that it withdraw from active participation in the transportation industry. MCW should also immediately acquire some systems help and increase its domestic prices. It is expected that the strategy presented above will return MWC to a sustainable growth and profit model while retaining its focus on what it does best and reflecting the wishes of the major shareholders.

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 2

INTRODUCTION

MCW is a small, family owned company with the shareholders functioning as hands on managers. In evaluating the options available to MCW, it is important to keep in mind the preferences of the shareholders as well as the normal objectives of for profit enterprises which normally focus on maximizing a combination of growth and profit, sometimes referred to as sustainable profit.

The purpose of this report is to provide a recommendation for a strategic direction for MCW. This strategic plan will be developed by using a systematic approach involving an evaluation of MCW’s environment, both internal and external, an evaluation of potential strategic options in the context of that environment and an assessment of related operational needs and business issues. On the basis of this analysis, recommendations and an implementation plan will be provided.

SITUATION ANALYSIS

MCW’s Mission Statement Although there is currently no formal mission statement in place at MCW, an implied mission statement could be developed as follows: “MCW produces quality component products for kitchen cabinets and provides its customers with the best prices in North America. MCW focuses primarily on its local Canadian housing and renovations market but also supplies American customers.” Shareholder Preferences The controlling shareholders are Brook and Lynn Michaels, although Brook, who holds the largest block of shares (60,000), does not have a controlling interest, since 60,000/140,000 is about 43%. It appears that Mr. and Mrs. Michaels have a preference for keeping the company. Mr. Michaels prefers to work for himself and would also like to have the freedom to do more specialty cabinet work. Mrs. Michaels is anxious to be more involved in the business. Situation Analysis A detailed list of strengths, weaknesses, opportunities and strengths can be found in Exhibit 1.

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 3

MCW offers a proven, quality product at a value-for-money price. So far, these characteristics have kept MCW running at close to capacity despite the fact that MCW does not offer completed kitchen cabinets and customers have to pick up their own purchases. Currently, MCW shows signs of the internal support not keeping up with the growth of the company. Such areas as management information systems and human resource management need to be addressed. The kitchen cabinet industry is a function of the housing and residential renovations markets and these markets have shown steady, if unspectacular, growth over the long-term. Thus, there would seem to be little risk of any sustained economic downturn in the industry. There has been sustained growth in the U.S. market and it makes up over 99% of the current Canadian export market and more than one-half the total Canadian market for kitchen cabinets. There are other export markets but, so far, nothing much in terms of volume has developed. The industry has a lot of participants of all sizes which produce many product and service combinations. Overall, the external environment looks to be attractive for MCW, a company that has yet to exploit its potential. As well, its favourable pricing is attracting fairly broad interest. However, at the moment, management is quite lean and is not well-equipped to take advantage of the variety of opportunities that may be available. Financial Assessment A few key ratios have been calculated as summarized in Exhibit 2. These ratios indicate that MCW is both in good financial health and is suffering declining performance results. The current ratio is a solid 2.35, but is not as high as in previous years. This is primarily a function of offsetting higher accounts receivable and accounts payable balances, although inventory is also higher. The first would have a direct impact on the second, and serves to leverage down the ratio. It is currently known that the high outstanding receivables relate to the overdue account of Belle Kitchen Products ($296,000) and that this situation has since been rectified. Both profitability ratios reflect good results for 2003, but these are still substantially less than for the preceding years. This trend is partly a function of a lower gross margin (37.8 % in 2003 compared to 40.7%, in 2002) and lower sales. The latter is a result of lost sales on the U.S. contract and will correct itself in the current year. The company has very little long-term debt and should be able to borrow against its fixed assets should the need arise.

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 4

There are two financial accounting issues that slightly distort the financial results. First, the accounting for the truck has resulted in the interest component of the loan not being recognized in the accounts as an expense and, second, the use of direct costing tends to understate the actual cost of inventory while simultaneously understating net income. No adjustments were made for these items in calculating the ratios. The loan adjustment would result in a slightly higher debt to equity ratio, and the two amounts would be offsetting for income purposes, with any net difference likely to slightly increase incomes (assuming that the inventory adjustment would exceed the interest adjustment). These issues are addressed later in the report.

STRATEGIC ISSUE ANALYSIS

The strategic issues to be addressed include the following: Alternative 1: Sell MCW to Charette Custom Cabinets (CCC) Alternative 2: Accept the proposal from JaCo Alternative 3: Set up a Bordertown plant Alternative 4: Expand or retreat from the transportation segment Alternative 5: Acquire control of Bordeleau Haulage Inc. (BHI) Alternative 1: Sell MCW to Charette Custom Cabinets (CCC) Some advantages and disadvantages of selling MCW are summarized below.

PROS

1. The proceeds would provide Brook with a

comfortable nest egg for the future. 2. The price is fair. 3. Employment is guaranteed for the existing

employees of MCW. 4. Brook’s life would be simplified. 5. Brook would be employed for 5 years.

CONS 1. There are serious restrictions on Brook’s

medium term future. 2. The non-competition clause may have

long-term implications should Brook and CCC part company after five years.

3. Brook does not want to be an employee. 4. Lynn will be unemployed. 5. MCW will effectively cease to exist.

Based on the information at hand, a price of $1.2 million seems more than fair. Incomes in the best years are around $100,000. Although Brook, Lynn and David receive good compensation, there is no indication that it is at all excessive. From CCC’s point of view, the expenses are probably understated (i.e. office in the home, no forklift expense). There is also the probability that MCW is understaffed and under equipped on the administrative side, although this may not matter to CCC.

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 5

In Exhibit 3, some calculations are performed that demonstrate that the price offered is satisfactory even assuming the optimistic future income of $200,000 per year before taxes. Most of the potential affecting factors would serve to reduce the calculated value of MCW. Summary Quantitatively, the offer is quite fair. Accepting this proposal, however, would significantly limit the short and medium term options available to MCW’s shareholders. It could be an optimal temporary position if Brook and Lynn Michaels decide that, in the longer term, they plan to take over BHI and the non-competition clause will offer no serious restrictions at that time.

Conclusion The price being offered by CCC is fair. In fact, the proposal is financially very rewarding. However, the overriding considerations may be qualitative. Sale of the business appears to be inconsistent with the preferences of the shareholders, at least at this time. Alternative 2: Accept the JaCo Proposal Some advantages and disadvantages of accepting the JaCo proposal are summarized below.

PROS 1. The contract is financially very profitable. 2. The new equipment will provide capacity in

excess of that needed for the JaCo contract, thus providing additional capacity of at least 6,000 units for other customers, where MCW currently operates at full capacity.

3. The equipment investment is fully recovered in 2 years.

4. This is a good time for MCW to make a decision of this magnitude, since the company is temporarily in flux.

5. The normal risks of dealing across borders and without much knowledge of a major customer are protected against under the terms of the contract (e.g. $US currency fluctuation, inflationary cost pressures).

6. Japan has previously been a minimal market for Canadian producers and offers significant potential to increase an already growing export market.

7. There is little chance of a significant market downturn.

CONS 1. The contract commits MCW to a particular

line of business (exporting boxes) for the medium term. This is a shift from the current focus on the local market.

2. The investment is substantial. 3. MCW knows very little about JaCo. 4. Entering the production of boxes on such a

large scale will substantially change the nature of MCW’s operations.

5. Dealing with exporting and shipping complicates operations and the first experience in this field produced some major difficulties.

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 6

The supporting analysis appears in Exhibit 4. Summary MCW will have the security of $US 150,000 in the event something goes wrong. The downside risk is minimal and its severity would be limited to whatever loss might have to be incurred should the equipment have to be divested on the previously owned market. This would only be necessary if other customers could not be located, and MCW currently has people knocking on their door both domestically and internationally. The upside seems to be almost unlimited if this first three-year contract is a mutual success. This first contract alone is more profitable than the offer from CCC for MCW. The profit potential on this contract will provide funds for MCW to shore up some of its operating areas and possibly free up Brook Michael to do more of the specialized cabinet work and kitchen installations that he enjoys. The possible negative aspects, namely exporting and shipping, are either to be handled by the purchaser or can be contracted out at no net cost to MCW. Conclusion If the overall strategy is to expand, this contract should be accepted. Alternative 3: Set up a Bordertown Plant A summary of pros and cons follows:

PROS

1. A U.S. plant could provide a basis for avoiding any $US fluctuation problems in terms of product costs and selling prices.

2. A U.S. address could attract business from customers that would not deal with a non-U.S. supplier.

3. Customs problems would be avoided on sales to U.S. customers.

CONS

1. Setting up a second plant would increase overhead.

2. The plant would require administrative staff, as well as woodworkers, thus stretching the administrative people more thinly, and removing the advantages of economics of scale.

3. Operating in the U.S. requires specialist compliance knowledge which is quite different from just selling to the U.S., and with which MSW is not familiar.

4. The business would be taxable in the U.S. as well as Canada, thereby increasing compliance costs. The Canada-U.S. Tax Treaty should prevent double taxation, however.

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 7

Summary Many larger participants in the industry have opened showrooms in American cities for the purpose of marketing their products. However, MCW does not operate in that segment. MCW operates on a basis of producing quality products and minimizing its overhead so as to be a price leader. Its primary customers are builders and renovation specialists, not the retail market. On balance, the disadvantages would seem to outweigh any possible benefits of opening such a plant at this time. Conclusion There is no significant reason to complicate MCW’s operations by opening a plant in Bordertown. Alternative 4: Expand or Retreat from the Transportation Sector Some advantages and disadvantages are provided below.

PROS

1. MCW owns a tractor-trailer that will be paid for by December 31, 2005, and two of its shareholder-managers are licensed to drive the vehicle.

2. MCW has some experience driving in the U.S.

3. Involvement in the transportation industry would diversify MCW’s operations.

4. Trucking can be profitable and MCW has made money in prior years.

5. Lynn Michaels likes the long haul driving. 6. If the JaCo proposal is accepted, MCW

could transport the boxes, thus increasing their transport business.

CONS

1. Transportation is entirely different from manufacturing boxes and MCW should focus on getting the box operation revitalized.

2. MCW has had its struggles with the transportation aspect of its operations and the added stress was apparent.

3. To make a profit in trucking, it is necessary to be able to find loads to bring on return trips, particularly if the driver represents an incremental cost. This would require increased administrative and marketing efforts and detract from the corporate focus of producing quality boxes.

4. MCW would be in direct competition with BHI.

5. Lynn Michaels no longer likes to be away for extended periods because of the children.

Summary MCW has the benefit of a direct connection with BHI, a company that is in the transportation business and could easily fit MCW’s required shipments into its regular operations. MCW has proven that it can be profitable in the kitchen cabinet business and it could easily do without the distractions of trying to keep large trucks full. It is likely also a good idea to do business with BHI rather than compete with them. Given the existing relationship, MCW might be able to get BHI to use their truck or at least the

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 8

trailers. Alternatively, as there is no longer a need to leave a trailer in Louisiana, MCW may wish to consider selling both the tractor and two trailers. Conclusion Given that MCW is currently not in the transportation business, although it has done some deliveries, it is not an opportune time to venture into a different industry in a big way. MCW can minimize its aggravation by contracting BHI to do its major shipping. Alternative 5: Acquire Control of Bordeleau Haulage Inc. (BHI) Lynn Michaels’ parents have expressed an interest in having Brook and Lynn Michaels take over BHI. The acquisition of BHI could be a very complementary step for either Mr. and Mrs. Michaels or MCW. Some advantages and disadvantages are provided below.

PROS

1. Because of the personal relationship between the Michaels and the Bordeleaus, it is likely that a mutually agreeable plan could be developed for the Michaels to take over BHI.

2. Lynn Michaels is already very familiar with all aspects of the business.

3. The transportation business has an aspect that can be complementary to the kitchen cabinet business.

4. Assuming that the Bordeleaus remain in good health, it is reasonable to assume that they would be available, as necessary, during and after any acquisition.

5. Since the value of the business is likely the source of the Bordeleau’s retirement income, planned payout from future profits may be possible.

CONS

1. At the present time, it is critical for Brook and Lynn Michaels to concentrate on putting MCW on a successful path without a major distraction.

2. Lynn Michaels cannot run both BHI and MCW at the same time.

3. There is no indication that Brook Michaels has any special interest in the transportation industry.

4. There will be financial obligations of some sort arising from ‘taking over’ BHI.

Summary If Brook and Lynn Michaels decide to accept the offer from CCC, a scenario including the acquisition could be developed. Lynn Michaels could go back to work for her parents, with a long-term plan of taking over the business when Brook Michaels completes his five-year contract with CCC. At that point, Lynn would likely be quite able to run BHI and could expect some support from her husband. He would also be free to start a small custom cabinet shop if he so chose.

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 9

However, given the preferred choice of continuing with MCW, for the time being, it would seem prudent to defer any decision on BHI until MCW is turned around and on track, with established internal systems and support. Conclusion Although BHI may be a consideration some time in the future, MCW requires the total focus of Brook and Lynn Michaels for the time being. The BHI opportunity is not likely to go away and, if anything happens to make a decision more pressing, it can be properly assessed at that time.

STRATEGIC RECOMMENDATIONS

Strategy The only mutually exclusive option available to MCW is to accept the proposal to acquire the company from CCC. The offer from CCC is a very fair one, based on the information available. However, the JaCo proposal analysis indicates that the proposal alone would provide a greater return to MCW and its shareholders than would selling the company to CCC. Taking the financial implications into account, and reflecting on the preference of the primary shareholders to keep operating MCW, it is recommended that the proposal to buy MCW be turned down. Based on the financial benefits, the fit with shareholder preferences and the fact that the purchaser is prepared to assume the currency risk and undertake the customs dealings, it is recommended that the JaCo proposal be accepted. It is further recommended that the required production equipment be acquired at a cost of $900,000 as soon as the $US150,000 is received. Given the size of the JaCo undertaking and the need for MCW to improve its internal operations in several areas, it is recommended that the Bordertown expansion not be pursued at this time. It is also recommended that MCW withdraw from the transportation business as a business line for the time being. MCW should offer its business to BHI at market but, even if BHI is not interested, however unlikely that is, MCW should plan on using existing commercial carriers for its export contracts. It is recognized that, in general, the trucking industry can be complementary to MCW’s kitchen cabinet business, particularly if the U.S. and Japanese markets turn out to be its big volume markets. It is also recognized that Guy and Judy Bordeleau will not wait forever to retire. However, given the closeness of the family and the current situation of

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 10

MCW, it is expected that a declaration of interest on the part of the Michaels may suffice for now, with a final decision to be made after MCW has some experience with the proposed strategic direction. Mission Statement Given the suggested recommendation, the implied mission statement is still appropriate, with the exception that the word “American” should be replaced by “International.” Ongoing Strategy Once the recommended strategy is in place, and operations return to normal, an ongoing process of reviewing the corporate strategy should be put in place.

ANALYSIS OF BUSINESS AND OPERATIONAL ISSUES

A. FINANCING

1. Acquisition of Equipment

Given the recommendation to proceed with the JaCo proposal, MCW will require $900,000 to purchase the required equipment. Part of the proposal is a security deposit of of approximately $175,000 (150,000/.85) and MCW is also expecting an insurance payment in the neighborhood of $300,000. This would leave a balance to finance of $425,000. Most banks would be willing to put up at least 50% of the cost of the equipment, particularly as MCW has only a minimum amount of debt. In the short-term, the insurance payout could be pledged against a bridging loan of $300,000. The analysis of the project is also available as support for the investment.

MCW could also lease the equipment.

If necessary, the shareholders could consider putting up personal guarantees, but this should be resisted on the basis that MCW is a sound enterprise in its own right.

Given that the insurance proceeds may not be immediately available but would appropriately be applied to replacing equipment, MCW should try to finance the purchase through its bank. Should additional financing be needed at a later date it would always be possible to re-finance the equipment.

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 11

Recommendation: Arrange financing for the equipment through the company bank.

2. Callable, participating, non-cumulative preferred shares.

Callable shares are redeemable at their face value at the discretion of the issuer. Participating preferred shares are shares that participate pro rata (equally) in any dividend that is paid on common shares. Non-cumulative preferred shares are normally preferred shares that have a stated annual dividend rate. This dividend must be paid before any dividend can be paid on common shares. Since they are non-cumulative, if the stated dividend is not paid in any given year, it does not carry forward as a prior requirement for payment before a dividend can be paid on the common shares. In the case of MCW, however, the preferred shares do not have a specified rate, so this particular feature is redundant.

B. PRICING Brook Michaels has expressed frustration with the fact that profits did not seem to grow in proportion to volume. An analysis of MCW’s pricing is detailed in Exhibit 5. It indicates, among other things, that MCW has had no price increases since the original price increase suggested by Pierre Tremblay before the turn of the millennium. Given that both materials and labor costs have been increasing at close to 5% annually, the real surprise is that MCW has managed to keep its margin close to its 1999 level. This was initially accomplished by switching to production lines from individuals making complete boxes. However, there was a significant drop in margin in 2003. The analysis shows that MCW’s prices are currently under that of its closest competitor by close to 15% and, because of MCW’s quality, it may not need to have the absolutely lowest price. Nonetheless, since MCW is dependent on its customers coming to the plant, it needs to have close to the best price. Since a 15% increase, all at once, could have a negative psychological impact on the local market, MCW may wish to attempt to close the pricing gap over a couple of years, rather than all at once. Recommendations: 1. Prices should be immediately increased by 7%, followed by additional increases of

5% in six months and in 12 months. 2. A plan to regularly review prices, preferably semi-annually but at least annually,

should be put in place.

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 12

C. HUMAN RESOURCES Although MCW is blessed with some quality people, human resources are currently in short supply. As a starting point, the Michaels (Brook, Lynn and David) should list the various things that they currently do. Brook Michaels should call a meeting to review these lists and new lists should be developed as appropriate. Based on available information, one change that would please everyone is to move the record-keeping responsibility from David Michaels to Lynn Michaels. Given that the JaCo proposal will be accepted, MCW should take the opportunity to hire a CMA. Such a person would be competent in financial accounting and would also be able to develop appropriate information systems. If desirable, the appropriate candidate would also be able to arrange for an e-commerce bank account to be integrated with the Web site, and to manage the Web site. This person should report to Lynn Michaels initially, with the expectation that they will become a senior manager reporting directly to Brook Michaels after a probationary period. It may be a good idea to hire an executive placement firm to find an appropriate person. Keeping in mind that low overhead is a key to MCW being successful, new positions should be kept to a minimum. However, the JaCo contract is projected to earn some $1.1 million alone in the coming year while simultaneously providing an additional 6,000 units of capacity for domestic market production. It would serve MCW well to devote some of this income to strengthening its administrative support. Some in-house opportunities currently exist. First, it appears that Peter Scales could be promoted to Assistant Manager, Production, reporting to David Michaels. Second, arrangements could be made to move Connie Portland into the administrative side of the operation, either part-time or full-time, as needed. Lynn Michaels will have plenty to do with her expanded administrative responsibilities, including taking over responsibility for the record-keeping. If Ms. Portland provides value for her time, there is no requirement that her wage be reduced. There would be some cost to promoting Peter Scales and both Connie and Peter would have to be replaced on the production line. However, the total cost should be well within $200,000 and should be money well spent with a view to the future. Although the existing owner-managers have been successful in managing MCW to date, the company is in a good position to expand. Accepting the JaCo proposal and purchasing the new equipment will do that almost immediately. The present management team has succeeded despite not having much in the way of formal training. This has been accomplished primarily because they are “people” people. In light of the expansion, however, and the potential for the future, it would be wise to introduce some more formal procedures and perhaps get some specialized training for

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 13

key people. As a start, Lynn Michaels may wish to take some management training and David Michaels should be encouraged to take some training in the human resources and marketing areas. Lynn Michaels has identifiable administrative skills and is known to be a problem solver. The effective use of these skills could be developed further through the acquisition of available management methodology. By relieving David Michaels of the record-keeping responsibilities and promoting Peter Scales to be his assistant, David could be freed up to become the Production Manager. This position would be designed to include the staffing of the production lines. David could also start to study marketing, in an organized fashion, although the need for additional marketing may not be immediate. (A proposed organization chart is included as Exhibit 6.) The preceding suggestions will also go a long way toward providing coverage for the manager positions should anything happen to incapacitate any of the Michaels. Under the proposed revised structure, Brook Michaels would be relieved of direct responsibility for production and he would still be available to fill in as may be needed from time to time. Some of Mr. Michaels’ time would also be available to further develop the specialty cabinet business should he so wish. These suggestions may still leave the administrative functions understaffed. For instance, it may be that this proposal puts too much responsibility on David Michaels, indicating a need for either or both of a human resources and marketing specialist. Management should ensure that this situation is monitored and any needed corrective action is taken. Job descriptions should be developed for each position. While this sometimes leads to a resistance on the part of employees to do tasks that are not included in their job description, this is a minimal risk compared to the benefits of employees knowing what is expected of them. The process of developing job descriptions will also be helpful to management, since it forces a review, or creation of, policies and procedures. Although it is not urgent, management should also plan to implement regular performance evaluation practices and procedures. In conjunction with developing these procedures, management may wish to consider implementing some form of standardized incentive program for MCW’s workers. D. MANAGEMENT INFORMATION SYSTEMS In the preceding section, it is suggested that the place to start developing information systems is with the hiring of a qualified CMA. It should be recognized that there are no existing systems to speak of as indicated by the financial accounting and pricing concerns, and the implementation of appropriate systems will require both time and

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 14

funds for the acquisition of satisfactory computer equipment (hardware and software) for this purpose. In this respect, although MCW is looking at a major volume expansion, its production processes are not very complicated and the volume is, at least initially, going to come from one customer, with predetermined needs and prices. Thus, satisfactory software should not be excessively costly. However, it is important for the Michaels to take the trouble to ensure that the new CMA is quite familiar with their needs prior to proceeding with the implementation of systems that will meet those needs, keeping potential future needs in mind but without including unnecessary and costly “bells and whistles” that provide little value for money. E. FINANCIAL ACCOUNTING As mentioned in the Financial Assessment section of the Situation Analysis, there are a couple of financial accounting treatments that should be corrected. 1. Accounting for the truck acquisition – repayment of the loan.

The difference between the cost of the truck and the repayment of the loan originally represented deferred interest but apparently was not set up in the accounts. Since the loan payments have been charged against the payable, the situation now reflects an understatement of the liability in an amount of somewhat less than $8,000, since part of the $24,000 still outstanding is interest.

Interest on the loan can be roughly estimated to be at a rate of 5.5% (taking the

average outstanding balance to be $40,000 over a period of three and two-thirds years, with average interest over that period at $2,180 per year, giving 2,180/40,000= 5.5%, approximately). For simplicity, the average balance outstanding for 2004 would be $18,000 [(24,000+12,000)/2] and, similarly, for 2005, it would be $6,000. The interest expense would then be $990 (5.5% x 18,000) for 2004, and $330 (5.5% x 6,000) for 2005.

The impact on income for the two remaining years is relatively small. However, a correcting entry to charge retained earnings with the prior year’s expense of some $6,680 (8,000 – 990 – 330) and increase the loan payable account should be made.

2. Inventory Currently inventory is valued on the direct cost basis, omitting overhead. A review of

the 2003 expenses suggests that shop expense ($37,000), a small part of amortization ($28,000 – $22,000 = $6,000) and perhaps part of the utilities expense (not known) should be included in cost of goods sold. Since the inventory is only 20% of the cost of sales before deducting the inventory [$176,000/(717,000 +

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 15

176,000)], an adjustment to inventory of about $8,600 (20% of 43,000) would be needed to record inventory on an absorption (full) cost basis.

For reporting purposes, both of these events, the correction of an accounting error and a change in an accounting principle, require retroactive adjustment. In effect, the 2004 financial statements should show adjusted 2003 comparative statements and the 2003 figures should reflect an opening retained earnings balance adjusted for the net change that would otherwise be needed to all years preceding 2003. Overall, the total impact is slight (8,600-6,680) and is arguably not material. F. BUY OR LEASE FACILITIES This decision is often made by circumstance. Some prospective occupants cannot raise the resources to purchase a property so their only choice is to lease. Others prefer not to have the complications of owning so they also choose to lease. In such cases, it may be that only properties offered for lease are even investigated. Some purchasers only investigate facilities that are for sale. Often, where the prospective occupant has the choice, this decision is made purely on the basis of financing costs. In other cases, the decision is made based on the facility that is preferred. Thus, the prospective occupant wants to use the property and must, therefore, agree to the preference of the owner to obtain use of it. Since, in MCW’s case, it appears that the cost will be similar whether the company leases or buys, there is a probable financial advantage to purchasing, since properties tend to go up in value over time. On the other hand, to the extent that the financing arrangements require repayment of principal, the impact on cash flow will be greater if a property is purchased. There may also be complicating factors related to the responsibilities assumed by each party under a lease arrangement. An owner may absorb some of the costs under some leases that would make leasing more attractive. In the absence of a specific situation, it is not possible to provide definitive advice. However, where the other factors are effectively equal, there is usually an advantage to owning. In the end, however, the decision will be one of corporate preference.

IMPLEMENTATION PLAN Although many suggestions and recommendations have been made in the body of the report, a detailed implementation plan is provided as Exhibit 7.

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 16

CONCLUSION

This report has analyzed the environment of MCW, both from a perspective of its internal strengths and weaknesses and from the perspective of its external opportunities and threats. This analysis has been taken into account in evaluating several possible strategies available to the company and in recommending a strategic direction going forward. In that context, existing and potential business issues and problems have also been examined. The implementation of the recommendations contained in the report should put the company on a solid basis, one that offers sustainable growth and reduced time pressure on the shareholders, particularly Mr. Brook Michaels, for the foreseeable future.

Mic

hael

s C

usto

m W

oodw

orki

ng L

td.

S

ampl

e S

olut

ion

CM

A C

anad

a

17

Exhi

bit 1

SWO

T SU

MM

AR

Y St

reng

ths

• B

rook

is te

chni

cally

sk

illed

• Ly

nn h

as b

road

ski

lls

- ad

min

istra

tive

- lic

ense

d fo

r tru

cks

• D

avid

has

goo

d kn

owle

dge

and

is a

lso

licen

sed

repu

tatio

n fo

r qua

lity

low

pric

es

• sh

op c

onve

nien

tly

loca

ted

BH

I tra

nspo

rtatio

n co

nnec

tions

full

capa

city

good

ban

king

re

latio

nshi

p

Wea

knes

ses

• ex

port

cont

ract

di

stra

ctin

g fo

cus

stre

ss o

n Br

ook,

Lyn

n an

d D

avid

bad

debt

man

agem

ent

• po

or c

omm

unic

atio

n be

twee

n m

anag

ers

• cu

stom

er s

ervi

ce

• no

del

iver

y

• in

adeq

uate

sta

ffing

no tr

aini

ng in

hum

an

reso

urce

man

agem

ent

• la

ck o

f pric

ing

polic

ies

Opp

ortu

nitie

s •

indu

stry

is e

xper

ienc

ing

stea

dy g

row

th

- do

mes

tic

- ex

port

• lo

ng-te

rm in

dust

ry

pros

pect

s ar

e go

od (l

ittle

ris

k of

obs

oles

cenc

e)

Inte

rnal

: •

sell

unas

sem

bled

box

es

• se

ll M

CW

expo

rt to

U.S

. •

JaC

o pr

opos

al

• ex

pand

cap

acity

dive

rsify

into

truc

king

, ot

her p

rodu

cts

Thre

ats

• in

dust

ry v

ery

com

petit

ive

• M

CW

is a

pric

e ta

ker

• en

viro

nmen

tal o

ppos

ition

$Cdn

incr

easi

ng in

co

mpa

rison

to th

e $U

S

• di

rect

cos

ts in

crea

sing

at

5% p

er y

ear

• bu

sine

ss is

sea

sona

l, pa

rticu

larly

in C

anad

a

Mic

hael

s C

usto

m W

oodw

orki

ng L

td.

S

ampl

e S

olut

ion

CM

A C

anad

a

18

Exhi

bit 2

FIN

AN

CIA

L A

SSES

SMEN

T O

F M

CW

Rat

io A

naly

sis

Type

of A

naly

sis

Des

crip

tion

2003

2

002

20

01

Liqu

idity

- c

urre

nt ra

tio

Pro

fitab

ility

- n

et in

com

e as

a %

of

sal

es

- ret

urn

on in

vest

men

t E

quity

- d

ebt t

o eq

uity

ratio

A

ctiv

ity

- ave

rage

day

s sa

les

in

acco

unts

rece

ivab

le

- tim

es in

vent

ory

turn

s o

ver a

nnua

lly

Cas

h +

Acc

ount

s R

ecei

vabl

e +

Inve

ntor

y A

ccou

nts

paya

ble

+ In

com

e ta

xes

paya

ble

N

et in

com

e be

fore

tax

annu

al s

ales

Net

inco

me

for t

he y

ear

Sha

reho

lder

s’ e

quity

Long

-term

deb

t S

hare

hold

ers’

Equ

ity

(o

peni

ng A

ccou

nts

Rec

eiva

ble

+ cl

osin

g A

ccou

nts

Rec

eiva

ble)

/2

annu

al s

ales

/365

Cos

t of S

ales

(o

peni

ng In

vent

ory

+ en

ding

Inve

ntor

y)/2

2.35

6.9%

14.2

% .03

100

4.88

4.36

10.9

%

28.0

% .11 53

5.63

2.78

13.0

%

37.0

% .24 40

5.30

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 20

Exhibit 3

Supporting Analysis of the Charette Custom Cabinets Offer

Considerations:

1. In the best years (2001 and 2002), MCW earned approximately $100,000 after tax. The most recent year, 2003, reflects earnings of $62,000. This drop is the result of problems with the contract with BKP which produced only one-half of the expected sales for 2003. The impact of this shortfall alone would be in the order of $285,000* [(92.80+78.60+66.00)/3) x 3,600]. Much of this production had served to fill in available capacity in slower parts of the year.

2. Brook Michaels believes that MCW can earn $200,000 a year before bonuses

and taxes in its current configuration. An argument to support this number can be constructed. Although income was only $79,000 in 2003, we see that this was caused by unexpected lost sales in the U.S. which have been replaced for 2004. A return to 2002 sales levels will provide an additional $31,160 (82,000 x .38) and a 10% price increase (see Exhibit 5) reduced to a 5% margin increase to allow for increased costs will produce an additional $61,750 (1,235,000 x .10 x .50). These changes alone, conservatively calculated, would produce a pre-tax income in the $170,000 range.

3. Even if a net income before taxes is reasonable, the after tax income would be

$156,000 [200,000 x (1-.22)].

*Assuming an equal number of each type of box is sold. It is more likely that one-half the boxes would be the Base 30 boxes, which would increase this number.

Calculation of estimated values:

A. Based on a capitalization rate of 15% (conservative) and assuming that an after-tax profit $156,000 is possible, MCW would have a value of $1,040,000 (156,000/.15).

B. CCC is offering $1,200,000, over four years as follows:

On closing $ 600,000 First three anniversaries ($200,000 x 2.283) 456,600 $1,056,600 Conclusion:

Even using the most optimistic valuation hypothesis, the offer from CCC exceeds the valuation of MCW.

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 21

Exhibit 4

Supporting Analysis of the JaCo Proposal

(Note: There are a number of ways to analyze the proposal. One acceptable way is to analyze it using a project model, where a three-year time frame is used. This would require estimating the value of the equipment at the end of three years. The method used below is an income model. Both models use cash flow discounting.) Assumption: The new equipment would be Class 43 equipment, subject to a 30% capital cost allowance rate (15% allowed in the first year). Revenue – first year Base 24 box 15,000 x $84 $1,260,000 Upper 24 box 7,500 x $74 555,000 Upper 12 box 7,500 x $66 495,000 $2,310,000 Cost of sales – materials Base 24 15,000 x $32.45 486,750 Upper 24 7,500 x $22.60 169,500 Upper 12 7,500 x $18.86 141,450 (797,700) Cost of sales – labour 6 employees (Note 1) 10,800 x $23 (248,400)

Cost of sales – estimated increases for 2004 Materials $797,000 x 5% 39,850 Labour 10,800 x $1 10,800

(50,650) Rent (Note 2) (40,000) Indirect costs (100,000) Estimated income before income taxes 1,073,250 Income taxes (Note 4) (1,073,250 - [.15 x 900,000]) 40% (375,300) Net income, first year (Note 3) $697,950 Estimated discounted income over contract term, at 20% (Note 5) $697,950 x 2.1 $1,465,695

Note 1: A single employee works 1,800 hours (37.5 x 48) under normal circumstances.

The new equipment will replace one line (four employees) and will require two additional employees, for a total of six employees and 10,800 hours.

Note 2: Not all the expected facilities costs will accrue to the new line. However, the

available data does not make it clear what the previous rent was or what the

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 22

new usage ratio will be. It is a safe assumption that the majority of facilities costs will accrue to the new line so the whole amount (which is relatively small in the context of the decision) has been included here.

Note 3: With the inflationary indexing in the contract, and the fact that taxes will be proportionately less in Year 2 but somewhat more in Year 3 (due to the CCA

impact), the first year income is a good, if marginally conservative, indicator of annual income. Note 4: The 40% tax rate is used under the assumption that MSW can attain a pre-tax

profit of $200,000 without this contract. Again, the approach is conservative. Note 5: 20% is used as a conservative rate of capitalization. Any smaller % will produce

a more favourable result. Conclusion:

The proposed contract is very profitable. In the first year, it will produce net cash of some $832,950 (697,950 + 135,000 [non-cash expense]. Thus, it will pay for the equipment in a little over one year.

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 23

Exhibit 5

Analysis of Pricing

Considerations:

1. MCW has not increased its prices since the initial price increase of 20%.

Product Calculation of 20% increase Current price Base 30 $76.79 x 1.2 = $92.15 $92.40 Upper 30 $65.41 x 1.2 = $78.49 $78.60 Upper 12 $54.69 x 1.2 = $65.63 $66.00

There is no significant difference between the 20% calculation and the current prices.

2. The margin increase in 2001 is due to the switch to production lines and the

continued increase in 2002 is due to having the production lines for a full year, this despite the continually increasing costs in those years.

3. MCW’s prices are currently significantly lower than its lowest Canadian

competitors. The lowest U.S. prices (using the Base 30 box as an example), though still significantly above those of MCW ($120 x .78/.85 = $110) are dropping as the value of the Canadian dollar increases. At par, the U.S. prices would still be higher, but not by much: $93.60 ($120 x .78/100) in the U.S versus $92.40 for MCW.

Summary: Under current conditions, MCW’s prices are well below the next lowest prices. Though MCW must price their goods no higher than the bottom of the range to be successful, their existing prices were competitive in the late 1990s and have not been increased since that time. This is despite the occurrence of significant cost increases in the industry over the same period of time. Conclusion: It would appear, from the analysis, that MCW’s prices are too low and could be increased by as much as 15% without significantly affecting sales volumes, particularly given the quality of the products.

Michaels Custom Woodworking Ltd. Sample Solution

CMA Canada 24

Exhibit 6

A Proposed Organization Chart

Brook Michaels President

David Michaels Manager of Production, Production Staffing and

Marketing

Lynn Michaels Manager of Administration

(New Hire-CMA) Financial and Information

Systems Manager

Peter Scales Assistant Manager, Production

Connie Portland Administrative Assistant

Production Staff (10 employees)

Mic

hael

s C

usto

m W

oodw

orki

ng L

td.

S

ampl

e S

olut

ion

CM

A C

anad

a

25

Exhi

bit 7

IM

PLEM

ENTA

TIO

N P

LAN

Impl

emen

tatio

n St

ep

Res

pons

ibili

ty

Tim

ing

Cos

t 1.

C

onta

ct J

aCo

and

acce

pt th

e co

ntra

ct

Bro

ok

Now

2.

Inve

stig

ate

the

purc

hase

of t

he re

quire

d eq

uipm

ent f

or th

e Ja

Co

cont

ract

D

avid

N

ow

3.

In

vest

igat

e an

d ar

rang

e fin

anci

ng fo

r the

equ

ipm

ent p

urch

ase

Bro

ok

Now

4.

Pur

chas

e eq

uipm

ent

Dav

id

On

rece

ivin

g Ja

Co

depo

sit

$900

,000

E

5.

Dis

cuss

the

situ

atio

n w

ith G

uy a

nd J

udy

Bor

dele

au; a

rran

ge fo

r the

sh

ippi

ng o

f exp

ort c

ontra

cts

Bro

ok a

nd L

ynn

As

soon

as

poss

ible

C

ost r

ecov

ery

6.

Incr

ease

pric

es b

y 7%

In

crea

se p

rices

by

5%

Lynn

Now

6

and

12 m

onth

s

7.

Arr

ange

for a

man

agem

ent m

eetin

g to

dis

cuss

cur

rent

and

pro

pose

d re

spon

sibi

litie

s an

d tra

nsfe

r of r

ecor

d-ke

epin

g to

Lyn

n B

rook

, Lyn

n an

d D

avid

A

s so

on a

s po

ssib

le

8.

Dev

elop

a p

lan

to re

gula

rly re

view

pric

es s

emi-a

nnua

lly

Lynn

A

s so

on a

s po

ssib

le

9.

Con

tact

an

exec

utiv

e re

crui

tmen

t firm

with

a v

iew

to h

iring

a C

MA

B

rook

N

ow

10

. Pre

pare

spe

cific

requ

irem

ents

for t

he C

MA

, aut

horiz

e th

e se

arch

, hire

C

MA

B

rook

A

s so

on a

s po

ssib

le

$60,

000*

11. R

estru

ctur

e or

gani

zatio

n as

agr

eed

Bro

ok, D

avid

and

Ly

nn

As

soon

as

poss

ible

12. P

rom

ote

Pet

er S

cale

s to

Ass

ista

nt M

anag

er, P

rodu

ctio

n D

avid

W

ithin

a m

onth

$1

0,00

0*

13. T

rans

fer C

onni

e P

ortla

nd to

adm

inis

tratio

n Ly

nn

With

in a

mon

th

14

. Hire

4 a

dditi

onal

em

ploy

ees

for p

rodu

ctio

n te

am

Dav

id

As

need

ed

4 x

$43,

200*

15

. Exp

lore

trai

ning

opt

ions

for L

ynn

and

Dav

id a

nd p

lan

train

ing

Lynn

and

Dav

id

With

in th

ree

mon

ths

$5,0

00 E

16. P

repa

re jo

b de

scrip

tions

for a

ll po

sitio

ns

Bro

ok, D

avid

and

Ly

nn

With

in s

ix m

onth

s

17. I

mpl

emen

t man

agem

ent a

nd a

ccou

ntin

g in

form

atio

n sy

stem

s (C

MA

) O

ngoi

ng

$50,

000

E

18. I

mpl

emen

t acc

ount

ing

adju

stm

ents

for t

ruck

loan

and

inve

ntor

y (C

MA

) D

urin

g y/

e fin

anci

al

stat

emen

t pre

p.

19. I

mpl

emen

t reg

ular

man

agem

ent m

eetin

gs, m

onito

r man

agem

ent

wor

kloa

ds a

nd ta

ke a

ctio

n, a

s ne

cess

ary

Bro

ok

Ong

oing

* =

annu

al c

ost

E =

est

imat

e


Recommended