The Awesome Products Business Valuation Case (2015)

| June 8, 2016

Question
The Awesome Products Business Valuation Case
Awesome is a small closely held company operating in the United States. Assume you
are in the early stages of preparing a business valuation on Awesome Products to assist
a potential purchaser..
Included in the case is a copy of Awesome Products, Inc. Unadjusted Income Statement
and Balance Sheet and Operating Expense detail for the periods ending December 31st;
all numbers are in thousands. All questions on this case use the attached data as basis.

Instructions: Complete each of the exercises. As always you will be graded on both content
(correctness) and organization of your answers.
1. Based on the information given, prepare the normalization entries for the years 2010 2014. Explain your reasons for each normalization entry.
2. Using the data you created in #1,
a. Prepare normalized and common size balance sheets for each year from
2010 – 2014; and (you may want to use excel but please remember do not
go too far over to the right. This makes it very difficult to print out)
b. Prepare a normalized and common size income statement for each year
from 2010 – 2014. (you may want to use excel but please remember do
not go to far over to the right. This makes it very difficult to print out)

3. Compute the following ratios listed using the normalized data for each of the 5 years.
Ratios to be calculated are:
1. Growth Ratios
1. Sales Growth Percentage
2. Earnings Growth Percentage
11. Cost Control Ratios
1. Cost of Sales/Sales

Industry Average
n/a
n/a

n/a

2. Gross Margin or Profit

41.2

3. Operating Expenses to Sales

37.4

4. Operating Margin or Profit
111. Turnover Ratios
1. Receivable Turnover
2. Inventory Turnover
1v. Profitability Ratios
1. Return on Assets
2. Return on Equity
v. Risk
1. Debt/Equity Percentage
2. Current Ratio
3. Interest Coverage

3.8

101.7

3.5

7.4
16.8

0.5
1.7

3.5

4. Trends: Analyze the ratios you calculated for each of the 5 years. Analyze and
explain why you believe they are indicative of issues (positive or negative) to your
planned valuation of Awesome Products Inc.
5. Using the normalized income statements developed above, estimate future income.
State why you believe the method you selected for estimating future is the most
appropriate for this company.

6. Based on the above exercises and a capitalization rate of 20%, calculate, using the
interest capitalization method, the value of Awesome Products, Inc.

Information needed for normalization entries
You have discovered the following information after reviewing the financial statements
and other company documents, and interviewing management.

1.

Net Sales
During the period 2010 through 2014, the company has expanded their product
line and opened new stores. This caused the increase in sales during this period.
An analysis of the information shows the following:

Year

Number of New Stores

Increase in Sales

2011

20%

2012

2

10%

2013

0

2014

2.

1

2

10%

Cost of Sales

Products purchased from the same supplier. Different cost of sales percentages,
due to different product lines.

3.

Salaries and Wages
Generally, the increase in salary expense was caused by hiring additional
employees to work in the new stores. Included in the account, Officers’
Compensation, is the salary of the owner, George Bigshot. His salary for the 5
year period has been:
2010 – $375,000
2011 – $400,000
2012 – $475,000
2013 – $500,000
2014 – $535,000

You have compared his salary to industry data, and the amount he receives
appears to be high. His compensation appears to be 15% above the industry
norm. June Bigshot is an employee and earns $35,000 per year recorded in Other
Salaries & Wages. From interviews and physical observation, it does not appear
that she has any responsibilities and is rarely at the business location. When
Awesome opened the last 2 stores in 2014, they hired experienced managers.
Each of these manager’s earn $5,000 more than the managers in the other stores,
this amount appears to be $3,000 above the norm in the industry.

4.

Selling Expenses
This category includes numerous expense items. The Advertising and Promotion
category is significantly higher in 2014 compared to previous years. The
marketing manager told you Awesome redesigned all their literature in 2014. The
cost of the design work and printing costs was $550,000.
After careful analysis, you notice that the Travel and Entertainment category has
increased steadily since 2010. After asking questions, you discover personal trips
that were paid for by the company. The annual amount for these trips, is as
follows: 2012 = $80,259; 2013 = $120,000; and 2014 = $200,000.
Other Selling Expenses, includes expenses for a condo owned by the company.
The condo was acquired in 2010, and was capitalized as an Investment on the
Balance Sheet (see Investments below). The company has incurred $20,000 per
year for the upkeep of the condo from 2010 – 2014. Also, in this category there is
$23,000 in 2013 and $500,000 in 2012 related to an employee strike. The strike
was settled and management does not anticipate any strikes in the future. Related
to the strike the legal fees to handle the situation were $100,500 in 2013 and
$80,750 in 2012. The legal fees were included in the General & Administrative
section.

5.

General & Administrative
The insurance account has increased significantly. Most of the additional cost is
due to the opening of the new stores. However, there is $10,000 per year of
property insurance on the condo, and $12,500 per year of real estate taxes for the
condo. The two stores opened in 2014 are in a specialty area, and the rent paid is
significantly higher than the other stores. The rent for each of these stores is
$48,000 per year, and the average rent for the other stores is $30,000 per year.
The use of office supplies appears to be very inconsistent. The amount fluctuates
greatly from year to year, but you could not find any reason for this.
In each year, that new stores were opened, the company took the maximum
deduction for Section 179 expenses of $18,500. This amount is recorded in the
Depreciation Section. Under normal circumstances these assets would be
depreciated over a 5 year period using straight line depreciation.
4

6.

Investments
The condominium was acquired in 2010 for $190,000. The condominium was
depreciated on the straight line basis over 30 years, starting at the beginning of
2010 with the land valued at $10,000. The balance in the Investment account was
reduced accordingly, instead of showing accumulated depreciation and the
depreciation expense was recorded in Other Expenses under the General &
Administrative category. The balance in the Investment account represents stock
that Mr. Bigshot trades on a regular basis. No gains or losses were incurred on
these investments.

7.

Dividends
Dividends of $100,000 were paid in 2011.

8.

Advances from Affiliates
This account represents funds borrowed from another company owned by Mr.
Bigshot. Awesome pays a fair rate of interest on the funds borrowed.

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