RomaCorral Foods Case CPA

CPA Mock Evaluation Performance Management Elective

CHARTERED PROFESSIONAL ACCOUNTANTS OF CANADA, CPA CANADA, CPA. © 2013, Chartered Professional Accountants of Canada. All Rights Reserved.

ELECTIVE (PERFORMANCE MANAGEMENT): Elective examinations will be 3 hours in length. Candidates will be given 4 hours to complete the examination, providing an extra hour to formulate their responses. The intention is to reduce the time constraint. The Elective examinations will be made up of a mix of objective-format questions and cases. The split and length may vary somewhat across the Electives to adapt to learning outcomes required. Elective examinations use larger and more complex cases than those used for Core 1 and Core 2, requiring a minimum of 60 and a maximum of 120 minutes to complete. The assessment of professional skill will continue in a multi-competency environment, always building on prior learnings, however, greater than 50% of assessment opportunities will be related to the Elective area being examined. Elective cases require candidates to simulate the “roles” they will play in real life, and therefore access will be provided to the reference tools they would use, where practical to do so. Below is an example of a longer case that is focused on the Performance Management competencies, drawing heavily on Core Finance competencies.

ROMACORRAL FOODS LTD. Suggested Time: 120 minutes (represents the time judged necessary to complete the question) Overview RomaCorral Foods Ltd. (RCFL) is a Canadian public company listed on the Toronto Stock Exchange (TSX) but controlled by its parent company – Entertainment, Food, and Leisure PLC (EFL), a British public company listed on the London Stock Exchange (LSE). The parent company reports under International Financial Reporting Standards (IFRS). RCFL owns and operates two chains of restaurants in Canada. One chain specializes in Italian cuisine (Roma Italian) and the other in mid-level steak house cuisine (Corral Steak House). History Parent Company – Entertainment, Food, and Leisure PLC (EFL) EFL is one of the largest companies in the hospitality business worldwide. The company’s European operations include a few hotel chains, several restaurant chains, and a chain of coffee shops. In Canada, EFL owns 75% of the common shares and all of the preferred shares of RCFL. RomaCorral Foods Ltd. (RCFL) RCFL operates under the following mission statement:



RomaCorral Foods Ltd. provides Canadian consumers with excellent food and refreshments at good value and in comfortable, relaxing surroundings while providing its investors with above-average returns through operational efficiency and selective, aggressive growth. In addition, RCFL adopted the following vision statement: RomaCorral restaurants are the preferred choice of North American consumers seeking high-quality food and refreshments at affordable prices. As of June 30, 2014, there were 70 Roma Italian (Roma) restaurants and 24 Corral Steak Houses (Corral) restaurants in mid- to large-sized cities throughout Canada.



In late 2014, Raymonde Plante became CEO of RCFL. Plante felt it would be wise to revisit RCFL’s operating strategies and, together with the board of directors, developed a high-level environmental scan (see Appendix 1). The Canadian Food Service Industry The food service industry is a large, dynamic, and innovative sector of the Canadian economy. The main segments in the food service industry and their market shares (shown as percentages) are as follows: 1. Full-service restaurants (35%) – Licensed and unlicensed fine-dining, mid-level, casual, and

family restaurants as well as restaurant/bar combinations. 2. Limited service restaurants (34%) – Quick-service (fast-food) restaurants, coffee shops,

cafeterias, food courts, and takeout and delivery outlets. 3. Social and contract caterers (6%) – Caterers supplying food services to institutions, airlines,

railways, recreational facilities, and special events. 4. Other food service providers (25%) – Bars, hotels, motels, resorts, hospitals, schools, prisons

and other institutions, department store cafeterias, vending machines, stadiums, movie theatres, street vendors, private clubs, seasonal entertainment operations, etc.

The following are considered the main reasons for a restaurant’s success: appropriate location and offerings for the target market, consistent quality of food and service, and effective capitalization. Supply chain management is essential to ensure high-quality food while controlling costs. Scheduling is another important factor in cost control, given that labour must correspond to demand. Individual restaurants have a wide range of operating results, as shown in the following table: Restaurant Financial Data as a Percentage of Sales – Industry Ranges

Food, beverages, and other direct materials 25% to 40%

Wages and benefits 25% to 40%

Operating expenses 7% to 13%

Occupancy expenses (rent, insurance, utilities, etc.) 4% to 14%

General and administrative expenses 1% to 5%

Income (loss) before interest, amortization, and taxes (1.5%) to 19%

Average net profit margin in the Canadian food service industry slowly improved from a low of 3.2% in 2007 to 4.5% in 2010 before declining to 4.3% in 2011.



RCFL Operations The organizational chart of the management team is contained in Appendix 2. Restaurant Operations – General Most of the Roma and all of the Corral restaurants are located near, or within, suburban shopping areas in mid- to large-sized Canadian cities. Most RCFL restaurants are served by public transportation and have sufficient no-charge parking nearby. RCFL restaurants are open six days per week for both lunch and dinner and on Sundays for dinner only. As is typical of full-service restaurants, RCFL outlets tend to be quiet on Mondays and become busier as the week progresses, with Sunday business being somewhat unpredictable. Each restaurant has a manager who is responsible for his/her restaurant’s operation. The RCFL head office is responsible for implementing and maintaining information and accounting systems, developing the corporate-wide supply chain, providing training support as needed, processing payroll, building new outlets, evaluating manager and restaurant performance, facilitating major repairs or renovations, maintaining insurance, developing chain-wide advertising and promotions, conducting internal audits, arranging for external audits, and managing corporate banking. Head office is also responsible for setting menus and prices. Both Roma and Corral outlets are considered busy restaurants. Most outlets operate at about 80% of their practical maximum capacity which is considered good in the industry. For purposes of evaluating the performance of the individual outlets in each chain, a benchmark is set at the average monthly sales per seat achieved by the restaurant with the highest annual sales in that division. Each outlet is expected to achieve at least 85% of this benchmark, as well as a target net profit margin set by head office each year. Compensation and Staffing At the restaurant level, RCFL pays competitive wages for managers, assistant managers, and kitchen workers and slightly more than minimum wage for bartenders, servers, and hosts/hostesses. Annual management bonuses for each restaurant are based on achieving the target average monthly sales per seat (i.e. at least 85% of the benchmark) and the target net profit margin. It is not difficult to hire staff for RCFL restaurants, but many of the better servers leave after a few years. This is puzzling because their restaurants are among the busiest in the industry, and servers’ tips tend to be higher at RCFL outlets than at most other restaurants.



Banking RCFL has used the Capital Bank of Canada (CBC) and they have built a good working relationship. CBC provides RCFL with 75% mortgage financing on each land and building purchase for a new restaurant, as well as a line of credit to a maximum of 50% of the total of accounts receivable and inventory. The line of credit is offered at the prime rate, and the mortgages at 0.5% below the bank’s basic long-term mortgage interest rate. As a company listed on the TSX, RCFL must submit annual, audited financial statements. (See Appendix 3) Current Situation As a result of the economic recession that began at the end of 2014, Canadian consumers continued to reduce discretionary spending in the first six months of 2015. Sales at Canadian restaurants fell, and experts predict that 2016 revenues will drop by 2.5%. Sales at full-service restaurants are expected to show the largest decline (3%) as cost-conscious consumers switch to limited-service restaurants, where sales are expected to decline less severely (1.5%). Many full-service restaurants with prime costs (direct materials and labour) greater than 65% of sales recorded losses in the first half of 2015. Some steak houses in Canada, which generally have higher prime costs than Italian restaurants, went out of business. In contrast, sales at coffee shop chains, which have higher prime costs (68%-72%) increased in the first half of 2015 and are predicted to remain relatively strong, resulting in an average increase in sales of 2% per year over the next two years. In fiscal 2015, RomaCorral Foods Ltd. (RCFL) experienced a 1.5% decrease in average annual sales per restaurant but an increase in overall sales as a result of opening six new restaurants. Overall profits increased, and RCFL paid a dividend of $2 per share on both the common and preferred shares. The EFL board of directors reduced its expectations for RCFL’s growth in net income after taxes. Instead of a growth rate of 20% per year, the board indicated it required RCFL to achieve an after-tax net profit growth rate target of 5% over the next two years (i.e. net income of $42,901,583 in fiscal 2017) and to pay a dividend of $2 per share annually on both common and preferred shares. The board also indicated that EFL would not be able to provide RCFL with any financing for at least the next three years. Senior Staff Meeting – July 2015 Plante assembled the senior staff to discuss possible Roma expansion onto the parcels of land that RCFL has options on.



Singh informed the group that RCFL currently holds options on parcels of land in locations that would be very suitable for opening 7 Roma outlets. Each option, which cost $50,000 at the end of 2013 (shown separately on the statement of financial position), gives RCFL the right to purchase the designated parcel of land for an additional $550,000 before January 1, 2016, at which time the options will lapse. The 2015 average income per restaurant in operation for more than one year and the performance targets for each division are highlighted in Appendix 4. During 2015, all restaurants met the sales target and most met the net profit margin target. Plante indicated that he expects the economy to stabilize soon and that the average sales per restaurant will remain at the fiscal 2015 levels in the foreseeable future. He also indicated that January 1, 2016, is the earliest any new restaurant could be ready to open. He expressed his concern in opening new restaurants without EFL’s financial support and provided the following summary of the required capital investments for each new restaurant:

Roma Outlet

Land (including cost of option) $ 600,000 Building $ 4,500,000 Furniture and equipment $ 1,000,000

The seven locations for proposed Roma outlets would not be suitable for steak houses. Initial promotional campaigns for the new Roma restaurants would cost approximately $50,000 per outlet. 1. In addition to providing RCFL with 75% mortgage financing for new land and buildings, CBC

is willing to refinance the existing mortgages (without a penalty) for up to 75% of the fair value of the land and buildings of existing restaurants, provided that the ratio of long-term debt (including the current portion) to equity does not exceed 2 to 1. As of June 30, 2015, the net fair value of RCFL’s land and buildings was approximately $405 million. The bank will charge RCFL 4% annual interest on its line of credit and issue new or refinanced mortgages (5-year term, amortized over 25 years) at 3.5%.

2. RCFL uses a discount rate of 10% after taxes and a 20-year time horizon for evaluating

investments in restaurants. Land values are expected to double in 20 years and the fair values of other assets are expected to equal their book values.

Required: As Alicia King, CPA, analyze the current situation of RomaCorral Foods Ltd., update the environmental scan, analyze the expansion alternative facing RCFL, and prepare a report for the senior management team advising them on the strategies to follow in order to meet the targets imposed by the parent company, EFL.



APPENDIX 1 ROMACORRAL FOODS LTD. ENVIRONMENTAL SCAN – DECEMBER 2014

Strengths Experience and expertise of parent

company and management Good reputation for quality food at

reasonable prices Growth of brand Consistency in outlet appearance and menu

pricing throughout Canada Good locations close to target markets Adequate parking and easy accessibility via

public transit Reliable supply chain that delivers good-

quality food Preferred client status with bank Good base of long-term customers

Weaknesses Inconsistencies in customer service among

restaurants High turnover of the better servers High debt load Room for improvement in production

volume (as a percentage of practical maximum capacity)

Recent reduction in sales per outlet

Opportunities Increasing consumer spending in Canadian

food service industry Shifting demand from fine-dining

restaurants to mid-level and fast-food restaurants

Expected decrease in some food prices (produce, beef, veal) over next nine years

Threats High competition in all food service markets High staff turnover in food service industry Economic downturn High price of wheat



APPENDIX 2 ROMACORRAL FOODS LTD. ORGANIZATIONAL CHART

As at June 30, 2015

Controller Alicia King

Information Technology

Ben Tang

Manager, Property

Development

Manager,

Marketing

Restaurant

Managers

Restaurant

Managers

Board of Directors

Anthony Pickens – Chair Mélanie Boucher James Finney – Audit committee Beryl Sayad Edgar Fortune – EFL representative Raymonde Plante Connie Buckner

President and CEO Raymonde Plante

Vice-President, Head Office Operations

Connie Buckner

Vice-President, Development Prosad Singh

Vice-President, Roma Division

Josh Belli

Vice-President, Corral Division Jackie Browne



APPENDIX 3 ROMACORRAL FOODS LTD.

CONSOLIDATED STATEMENT OF FINANCIAL POSITION As at June 30

(in thousands of dollars)

Assets 2015

(draft) 2014

(audited) 2013

(audited) Current Assets: Cash $ 3,027 $ 2,692 $ 2,692 Accounts recivable 3,095 2,778 2,778 Inventory 14,487 12,479 12,479 Land options 680 630 630 Other 699 429 429 21,988 19,008 19,008 Non-current Assets: Land 60,290 68,690 43,690 Buildings 368,320 337,770 334,780 Less: Accumulated depreciation 30,395 21,586 21,586 337,925 316,184 313,194 Furniture and equipment 111,346 103,346 103,346 Less: Accumulated depreciation 38,164 27,430 27,430 73,182 75,916 75,916 471,397 460,790 432,800 Total Assets $493,385 $479,798 $451,808

Liabilities and Shareholders’ Equity Current Liabilities: Bank line of credit $ 2,100 $ 1,600 $ 1,600 Accounts payable and accrued liabilities 19,662 19,379 19,379 Current portion of long-term debt 8,562 6,904 6,904 Due to parent 4,000 21,000 21,000 34,324 48,883 48,883 Long-term Liabilities: Deferred taxes 9,182 12,712 1,512 Mortgage payable (net of current portion) 274,579 258,616 258,616 Total Liabilities 318,085 320,211 309,011 Shareholders’ Equity: Common shares 70,000 70,000 70,000 Preferred shares 10,000 10,000 10,000 Revaluation surplus 7,800 15,000 – Retained earnings 87,500 64,587 62,797 175,300 159,587 142,797 Total Liabilities and Shareholders’ Equity $493,385 $479,798 $451,808

As at June 30, 2015, there were 7 million common shares and 1 million preferred shares outstanding.



APPENDIX 3 (continued) ROMACORRAL FOODS LTD.

CONSOLIDATED STATEMENT OF CONPREHENSIVE INCOME For the years ended June 30

(in thousands of dollars)

2015

2014

2013

Sales $340,095 $308,675 $308,675

Variable restaurant costs:

Food and beverages 103,475 93,825 93,825

Salaries, wages and benefits 95,390 87,098 87,098

Other variable costs 8,559 7,534 7,534

207,424 188,457 188,457

Contribution margin 132,671 120,218 120,218

Expenses:

Facilities (excluding amortization) 13,618 12,107 12,107

Selling, advertising and promotion 6,461 6,040 6,040

General and administration 11,115 10,356 10,356

Interest 17,129 14,641 17,631

Change in fair value of options (50) (30) (30)

Depreciation – buildings 8,808 7,622 7,622 Depreciation – furniture and

equipment 10,735 9,565 9,565

67,816 60,301 63,291

Income before taxes 64,855 59,917 56,927

Income taxes (40%) 25,942 23,971 22,771

Net income 38,913 35,946 34,156 Other comprehensive income item

Change in revaluation surplus net of tax (7,200) (3,000) –

Comprehensive Income $ 31,713 $ 32,946 $ 34,156 Supplemental Schedule – Reconciliation of Retained Earnings

Opening retained earnings $ 64,587 $ 40,641 $ 40,641

Net income 38,913 35,946 34,156

Dividends (16,000) (12,000) (12,000)

Closing Retained Earnings $ 87,500 $ 64,587 $ 62,797



APPENDIX 3 (continued) ROMACORRAL FOODS LTD.

RATIO AND PERFORMANCE ANALYSIS

Ratios 2015 2014 2013

Current ratio (liquidity) 0.64 0.39 0.39

Quick ratio (liquidity) 0.18 0.11 0.11

LT debt-to-equity (coverage) 1.62

1.66

1.86

Total debt-to-equity (coverage) 1.81 2.01 2.16

Total debt-to-total assets (coverage) 0.64 0.67 0.68

Times Interest Earned (coverage) 4.79 5.09 4.23

Inventory turnover (activity) 7.14 times (51.12 days)

7.52 times (48.54 days)

7.52 times (48.54 days)

Asset turnover (activity) 0.69 0.64 0.68

Net margin or return on sales (profitability)

11.44% 11.65% 11.07%

EPS (profitability) $5.27 $4.92 $4.67

Contribution margin % (profitability)

39.00% 38.95% 38.95%

Return on equity (ROE) (profitability) 22.20% 22.52% 23.92%

Return on assets (ROA) (profitability) 7.89% 7.49% 7.56%

Revenue growth 10.18% 23.44%


APPENDIX 4 ROMACORRAL FOODS LTD.

SELECTED FINANCIAL DATA FOR A ROMA RESTAURANT For the year ended June 30, 2015

(in thousands of dollars-except target average monthly sales per seat)

Roma1 Sales $ 3,197

Food and beverages 902 Salaries, wages and benefits 869 Other variable costs 8

5

Total variable costs 1,856

Contribution margin 1,341

Facilities (excluding amortization) 140 Selling, local advertising and promotion 21 General and administration 54 Depreciation – building 81 Depreciation – furniture and equipment 98 Head office allocation2 291

685

Income before taxes 656 Income taxes (40%) 26

2

Net income $ 394

Number of seats 200 Target average monthly sales per seat3 $ 1,231 Target net profit margin 12%

1 Amounts represent the average sales and expenses for restaurants that have been

operating for more than one year. 2 Head office costs (including regional office costs) are allocated evenly to the individual

outlets. Total head office costs were $27,456,000 in fiscal 2014 and $29,071,000 in fiscal 2015. These costs are expected to be $31,200,000 in fiscal 2016 and $32,600,000 in fiscal 2017.

3 The target average monthly sales per seat for performance evaluation purposes is set at 85% of the benchmark. The benchmark is set at the average sales per seat achieved by the restaurant with the highest annual sales in that division.



MARKING GUIDE ROMACORRAL FOODS LTD.

This case focuses on candidates’ ability to analyze a situation and then to analyze the strategic options presented and suggest a course of action that is consistent with their analysis. This particular case also draws heavily on candidates Core Finance skills for their quantitative analysis. Candidates are expected to use their judgment in assessing which issues are the most relevant and to what extent these issues should be analyzed.

SITUATIONAL ANALYSIS

Assessment Opportunity #1 The candidate performs a detailed environmental analysis.

CPA Mapping Core PM-Elective

2.3.1 Evaluates the entity’s strategic objectives and related performance measures

B A

2.3.2 Evaluates the entity’s internal and external environment and its impact on strategy development

B A

The following tables list the points candidates are expected to present.

Mission: RomaCorral Foods Ltd. provides Canadian consumers with excellent food and refreshments at good value and in comfortable, relaxing surroundings while providing its investors with above-average returns through operational efficiency and selective aggressive growth.

Vision: RomaCorral restaurants are the preferred choice of North American consumers seeking high-quality food and refreshments at affordable prices.

Strategic Goals:

Achieve an after-tax net income growth rate target of 5% over the next two years (i.e. net income of $42,901,583 in fiscal 2017). Pay a dividend of $2 per share annually. Obtain an average return on investment of 10%.

Stakeholders’ Preferences:

Singh Indicated that options on parcels of land that would be suitable for opening Roma outlets.

Plante Questioned the feasibility of opening new restaurants without any financing from EFL.



Key success factors Location Menu Food and service quality Capitalization Supply chain management Scheduling of labour

Constraints The bank is willing to refinance the existing mortgages for up to 75% of fair value of land and buildings of existing restaurants, provided that the ratio of long-term debt to equity does not exceed 2 to 1.

Environmental Scan/SWOT Analysis: The following are some additional SWOT points that candidates may provide in their responses.

Strengths Weaknesses

Overall profits increased for RCFL and all restaurants met the sales target and most met the net profit margin target.

RCFL holds options on 12 parcels of land. Bank will refinance the existing mortgages

for up to 75% of the fair value of the land and buildings.

Many full-service restaurants with prime costs (direct materials and labour) greater than 65% of sales recorded losses. RCFL prime costs are less than 65%.

EFL would not be able to provide financing for three years.

Head office costs are allocated evenly to the individual outlets.

RCFL experienced a 1.5% decrease in average annual sales per restaurant.

Annual management bonuses are based on achieving the target average sales per seat and the target net profit margin; weakness is that there are no qualitative measures for performance evaluation.

RCFL outlets tend to be quiet on Mondays

Opportunities Threats

Plante indicated that she expects the economy to stabilize soon.

Restaurant revenues will drop by 2.5% in 2016.

Sales at full-service restaurants are expected to show the largest decline (3%).

Cost conscious consumers are expected to switch to limited-service restaurants.

Sales at limited-service restaurants are only expected to decline 1.5%.



Situational Analysis Point Description

Mission/Vision Consistent with the mission/vision?

Goals Meets goals?

Stakeholder Needs/Preferences

Stating if an alternative does or does not meet a specific stakeholder’s need or preference.

Constraint E.g. Calculating the debt: equity and comparing it to the bank’s constraint of 2:1.

KSFs In order to link to a KSF, it must be valid and considered in the analyses of the alternatives.

Strengths Option/issue strengthens or uses a strength.

Weaknesses Option/issue must:

1. address how the alternative/ action will solve the weakness, or

2. use the weakness for justification of not doing something, or

3. discuss how the alternative/option will worsen an existing weakness.

Opportunities Must indicate how alternative/option takes advantage of the opportunity.

Threats Must use the threat as a justification for not doing something or must indicate how the option/action would address a threat.

Financial Assessment:

Assessment Opportunity #2 The candidate performs a financial analysis of the company (part of environmental scan).

Also draws on Core competencies in Finance:

5.1.1 Evaluates the entity’s financial state (i.e. ratio analysis, benchmarking, etc.)

B NA

The following are some points that may be made in discussing the current financial situation of the company (either in the SWOT analysis or in a separate financial assessment section or in the analysis of the issues). Ratio Analysis: Liquidity is low (although not completely unexpected given that the majority of restaurant

sales would be cash/credit card leaving the receivables lower than in a traditional business which impacts the current assets).

Coverage appears to be adequate, below the bank’s benchmark of 2:1. Inventory turnover has been declining which is a concern in the restaurant industry where

good-quality food is of importance. Accounts receivable turnover is low, staying steady at just over 3.32 days which is expected

due to the cash nature of the business. Revenues are growing, and profitability ratios remain steady.



Benchmarks – See Appendix 1: Food and beverage cost of sales, restaurant salaries, wages and benefits, facilities

expenses, general and administrative expenses and operating expenses are all well in line with the industry benchmarks.

Income before interest, depreciation and tax, and net margin are both well above the industry benchmarks.

Prime costs are lower than the benchmark. Net income and revenue growth both exceed the benchmarks. Overall, RCFL appears very efficient operationally as compared to industry benchmarks and is growing faster and more profitably than its peers. Analysis of Strategic Alternatives

Assessment Opportunity #3 The candidate assesses the strategic alternatives.

CPA Mapping Core Elective

2.3.3 Evaluates strategic alternatives B A

Also draws on Core knowledge in Finance:

3.5.1 Performs sensitivity analysis A N/A

5.1.2 Develops or evaluates financial proposals and financing plans

B N/A

5.2.3 Evaluates sources of financing B N/A

5.2.5 Evaluates the entity’s cost of capital B N/A

Net income shortfall calculation – See Appendix 1 RCFL will need to overcome a $6,106K shortfall to meet its goal of $42,902K net income in

2017. The following are some relevant decision analysis concepts and tools that could be applied in the quantitative analyses of the strategic alternatives: Cost and revenue analysis

Relevant revenues, costs, contribution margins, opportunity costs, cash flows, break even, and/or net income are appropriately calculated and interpreted for the alternatives or for the recommended strategy. Assumptions are clearly indicated and are reasonable.



After-tax net income for 2016 The incremental or total after-tax net income is calculated for the alternatives or for the recommended strategy and compared to the target (i.e. $41,863,800 for RCFL overall). The increase in head office costs is included in the calculation of the required incremental income for 2016 or in the calculation of total 2016 net income for each alternative or for the recommended strategy. Capital budgeting / discounted cash flow analysis Appropriate capital budgeting or discounted cash flow analysis methods (e.g. net present value, internal rate of return, capital rationing) are applied correctly in analyzing the alternatives. For example, the following are included in the analysis: (i) appropriate operating cash inflows and outflows for each year, capital costs and other one-

time cash flows (non-cash items and interest are not included); (ii) consideration of the time value of money using the 10% after-tax rate over 20 years; (iii) after-tax cash flows; and (iv) calculation of CCA tax shields on capital cost using a reasonable CCA rate (e.g. 4% for

buildings and 20% for furniture and equipment). Note that candidates’ quantitative analyses may be very different, given the different assumptions they will make in preparing them (e.g. assumptions regarding prices, sales volumes, etc.). Their assumptions should be clearly stated and generally consistent with the case information. Other Quantitative Issues Other quantitative tools are applied appropriately in the response, such as the following: Financing required and available The financing required for the strategic alternatives and dividends ($16M) and the financing available [e.g. remortgage current properties (75% x current value – current mortgage outstanding), mortgage of new properties (75% x building and land costs for new outlets), line of credit (50% of accounts receivable and inventory), cash flows generated from future operations] are calculated and compared for each alternative and/or for the recommended strategy. Financial forecast A financial forecast for one or more years that incorporates the expected effects of the major recommendations is prepared. This can be in the form of a pro forma income or cash flow statement, or a pro forma balance sheet.



Recommendations and Conclusions

Assessment Opportunity #4 The candidate recommends an appropriate course of action (consistent with analysis).

2.2.1 Assesses whether management decisions align with the entity’s mission, vision, and values

B A

2.4.1 Analyzes the key operational issues and alignment with strategy

B A

For this case, support should include quantitative analysis that proves that the recommended actions would provide the following (i.e. integration of the constraints and goals, etc): 1. EFL’s target of a 5% growth in after-tax net income over the next two years (i.e.

$42,901,583 in fiscal 2017) will be met.

2. The bank’s constraint that the long-term debt (including the current portion) to equity ratio does not exceed 2 to 1 will be met.

3. RCFL will be able to acquire the financing required to implement the recommended strategy. 4. A 10% after-tax rate of return over 20 years will be achieved for the recommended capital

investments.

5. Sufficient cash flows will be generated to enable an annual dividend payout of $2 per share (i.e. $16 million).

Sample Analysis The following appendices provide sample analyses to assist the markers in recognizing valid points and calculations made by candidates.



APPENDIX 1 FINANCIAL ASSESSMENT Figure 1: Benchmarks

Formula 2015 2014 2013 Benchmark

Food and beverage % of sales

Food and beverage

cost of sales / sales

$103,475/ $340,095 = 30.43%

$83,825/ $308,675 = 27.16%

$83,825/ $308,675 = 27.16%

25.00%-40.00%

Restaurant salaries, wages and benefits % of sales

Restaurant salaries,

wages and benefits /

sales

$95,390/ $340,095 = 28.05%

$87,098/ $308,675 = 28.22%

$87,098/ $308,675 = 28.22%

25.00%-40.00%

Facilities % of sales

Facilities (excl. amort.)

/ sales

$13,618/ $340,095 = 4.00%

$12,107/ $308,675 = 3.92%

$12,107/ $308,675 = 3.92%

4.00%-14.00%

General and administration % of sales

General and admin. /

sales

$11,115/ $340,095 = 3.27%

$10,356/ $308,675 = 3.35%

$10,356/ $308,675 = 3.35%

1.00%-5.00%

Operating expenses % of sales

Total expenses - head office expenses /

sales

($67,816-$29,071)/

$340,095 = $38,745/ $340,095 = 11.39%

($60,301-27,456)/

$308,675 = $32,845/ $308,675 = 10.64%

7.00%-13.00%

Income before interest, depreciation and tax % of sales

(Income before tax +

interest + depreciation)

/ sales

($64,855 +$17,129 +$8,808

+$10,735)/ $340,095 = $101,527/ $340,095 = 29.85%

($59,917 +$14,641 +$7,622

+$9,565)/ $308,675 =

$91,745/ $308,675 = 29.72%

($56,927 +$17,631 +$7,622 +$9,565)/

$308,675 = $91,745/ $308,675

= 29.72%

(1.50%)-19.00%

Prime costs % of sales

(Food and beverage

cost of sales + restaurant

salaries, wages and benefits) /

sales

($103,475 +$95,390)/ $340,095 = $198,864/ $340,095 = 58.47%

($93,825 +$87,098)/ $308,675 = $180,923/ $308,675 = 58.61%

($93,825 +$87,098)/ $308,675 =

$180,923/ $308,675 = 58.61%

65.00%

Net margin or return on sales

net income / sales

$38,913/ $340,095 = 11.44%

$35,946/ $308,675 = 11.65%

$34,156/ $308,675 = 11.07%

3.20-4.50%



Formula 2015 2014 2013 Benchmark

Net income growth (net income current year - net income prior year) / (net income prior year)

($38,913- $35,946)/ $35,946

= $2,967/ $35,946 = 8.25%

($34,156- $25,692)/ $25,692 = $8,464/

$25,692 = 32.94%

20.00%

Revenue growth (revenue current year - revenue

prior year) / (revenue

prior year)

($340,095- $308,675)/ $308,675

= $31,420/ $308,675 = 10.18%

($308,675- $250,067)/ $250,067

= $58,608/$250,067 = 23.44%

(3.00%)



Figure 2: Net Income Shortfall for 2017

Net Income for 2016 – No Expansion: Formula/Source Roma Corral Total

2015 income before taxes $656 $799 $64,855

Increase in head office costs1 $31,200-$29,071 21 21 2,129

2016 income before taxes 635 778 65,726

Income taxes (40%) 254 311 26,290

2016 net income $381 $467 $39,436

2015 net income 394 479 38,913

Incremental net income (2016 – 2015) $(13) $(12) $523

Net Income for 2017 – No Expansion:

2015 income before taxes $656 $799 $64,855

Increase in head office costs1 $32,600-$29,071 35 35 A1 3,529

2017 income before taxes 621 764 61,326

Income taxes (40%) 248 306 24,530

2017 net income $373 $458 $36,796

2015 net income 394 479 38,913

Incremental net income (2017 – 2015) $(21) $(21) $(2,117)

Target 2017 net income A2 $42,902

Shortage in 2017 net income (need from expansion) $42,902-$36,796 A3 $6,106

Target 2017 net income Case A2 $42,902

2015 net income Case A4 $38,913

1 Assumes continued equal distribution of head office costs among 100 outlets.



APPENDIX 2 ANALYSIS OF ALTERNATIVE TO EXPAND ROMA QUANTITATIVE ANALYSIS Figure 1: Net Present Value Analysis

Incremental Cash Flow from Operations (One Outlet): Formula/ Source Roma

Net income (assume same as 2015) $ 394

Add back tax 262

Add back depreciation – building 81

Add back depreciation – F&E 98

Add back HO allocation 291

B1 1,126

Less tax @ 40% 450

Cash flows (not including increase in HO costs*) 676

PV factor (10%, 20 years) 8.51356

Present value of cash from operations – 1 outlet $ 5,755

Roma initial promotion ($50K x (1-0.4) x 0.909) (27)

CCA tax shield (Note 1) 746

Less investment for capital assets B3&B4 (6,050)

Net present value 1 outlet $ 424

NPV Total New Outlets:

NPV one outlet B5 $ 424

Number of outlets B7 7

Total NPV B5*B7; B6*B8 B9 $2,968

Note 1: CCA Tax Shield2 per Outlet:

Building (4%) $4913

Furniture and equipment (20%) 2554

Total CCA tax shield per outlet $746

2 [(CdT)/(d+k)]*(2+k)/[2*(1+k)]

3 [($4,500*0.04*0.40)/(0.1+0.04)]*(2+0.1)/[2*(1+0.1)]

4 [($1,000*0.2*0.40)/(0.1+0.2)]*(2+0.1)/[2*(1+0.1)]



Figure 2: Financing Required

Financing Required (One Outlet):

Formula/ Source Roma Only

Land $ 600

Building 4,500

Furniture and equipment 1,000

Total 6,100

Sunk cost (50)

Cash investment required for capital assets B3 $6,050

Total Financing Required:

One outlet B3&B4 $ 6,050

Number of outlets B7&B8 7

Total financing required $42,350

Financing available:

Land $ 600

Building 4,500

Base for mortgage $5,100

75% mortgage available from bank B11 $3,825

Cash investment required for one outlet B3&B4 $ 6,050

75% mortgage available from bank B11&B12 (3,825)

Required to be financed from other sources B13 2,225

Number of outlets B15 7

Total required to be financed from other sources B13*B15; B14*B16 $15,575

Total financing available from remortgaging (Note 1) B17 $20,609

Total financing available from line of credit (Note 2) f 6,691

Surplus (shortage) $11,725

Note 1: Financing Available from Remortgaging Existing Outlets:

Current value of land and buildings $405,000

Max total mortgages $405,000 x 75% 303,750

Mortgage owing end of 2015 $274,579+$8,562 283,141

Max available from bank from remortgaging B17 $ 20,609

Note 2: Financing Available from Line of Credit:

Accounts Receivable a $ 3,095

Inventory b 14,487

Total a+b c 17,582

Max available from bank @ 50% c*50% d $ 8,791

Less: current balance e $(2,100)

Financing available from line of credit d+e f $ 6,691



Figure 3: Impact on Net Income

Net Income for 2016: Formula/ Source Roma

Cash flow from operations before tax – 1 outlet

B1&B2 $1,126

Depreciation – building (Note 1) c&d 112.5

Depreciation – F&E (Note 1) j&k 100

Income before tax and HO allocation 913.5

Number of outlets 7

Total income before taxes from new outlets B18 6,395

Income taxes (40%) 2,558

Net income from new outlets B21 $3,837

2017 Target Net Income Shortage A3 $ 6,106

Surplus (shortage) B21-A3; B22-A3;

B23-A3 ($2,269)

Alternative Calculation:

Total income before taxes from new outlets B18 $ 6,395

Incremental head office costs A1 3,529

Incremental income before taxes 2,866

Income taxes (40%) 1,146

Incremental net income B24 1,720

2015 net income A4 38,913

Estimated net income for 2017 B24+A4; B25+A4;

B26+A4 B27 $40,633

Target 2017 net income A2 42,902

Surplus (shortage) B27-A2; B28-A2;

B29-A2 ($2,269)

Note 1 – Depreciation per New Outlet:

Building a $4,500

Useful life (years) b 40

Amortization per year per outlet straight line a÷b c 112.5

Number of outlets e 7

Total incremental amortization – building c*e; d*e f $787.5

Furniture and equipment h $1,000

Useful life (years) i 10

Amortization per year per outlet straight line h÷i j 100

Number of outlets l 7

Total incremental amortization – building j*l; k*l m $700.0

Figure 4: Impact on Debt: Equity



Financing Required: Formula/ Source Roma

Cash investment required for capital assets per outlet B3 $ 6,050


Total financing required B3*B7; B4*B8 B30 $42,350

Financing available:

75% mortgage available from bank B11&B12 $ 3,825


Mortgage financing B11*B7; B12*B8 B32 $26,775

Required to be financed from other sources B30-B32; B31-B33 B34 $15,575

Current equity as at June 30, 2015 B36 $175,300

Current long-term debt as at June 30, 2015 (includes current portion) B37 $283,141

Additional debt B34&B35 $ 15,575

New long-term debt B34+B37; B35+B37 B38 $298,716

New debt: equity B38÷B36; B39÷B36 1.70:1



Qualitative Analysis

Pros Cons

This would let RCFL exercise its options on 12 parcels of land in suitable locations (S).

This would let RCFL spread its growing head office overhead over more locations (W).

Has a positive net present value over the next twenty years (see Appendix 2, Figure 1) – the expected NPV is $5,988K.

Additional net profit exceeds net income goal by $872K (see Appendix 2, Figure 3) (G).

1.70:1 D:E would not exceed requirement from the bank (Appendix 2, Figure 4) (C).

RCFL has strength in experience and expertise in management and operation of Roma and Corral outlets (S).

Expanding outlets would build upon a recognized strength for a good reputation for quality food at reasonable prices (S/KSF/M).

Expansion could also take advantage of increasing consumer away from fine-dining (O).

High wheat prices increase the cost of pasta, which squeezes margins at Roma outlets (T – for Roma).

Sales at full-service restaurants are expected to show the largest decline (3%) which would impact success (T).

There is a continuing threat of high competition in all food service markets, which is exacerbated by the overall decrease in sales at Canadian restaurants in first half of 2015 and forecast decline in sales at full-service restaurants (T).

RCFL would not be able to immediately undertake a full expansion (12 stores), owing to financing constraints (see Appendix 2, Figure 2).

M: Mission V: Vision G: Goals C: Constraint K: Key success factor S: Strength W: Weakness O: Opportunity T: Threat A1: Alternative 1 A2: Alternative 2 TG: Target SP: Stakeholder’s preference APPENDIX 3 DIVIDEND CONSIDERATIONS Candidates should also consider the payment of the dividend in their recommended strategy. A basic calculation showing the cash flow/income generated and comparing it to the $16M dividend required is sufficient. If pro forma statements are prepared, this dividend payment may/should also be reflected here for reference.

RomaCorral Foods Case CPA

Documents

Transcript of RomaCorral Foods Case CPA