The Graham Products Business Valuation Case

| September 28, 2018

The Graham Products Business Valuation CaseGraham is a small closely held company operating in the United States. Assume you are in theearly stages of preparing a business valuation on Graham Products to assist a potential purchaser.Included in the case is a copy of Graham Products, Inc. Unadjusted Income Statement andBalance Sheet and Operating Expense detail for the periods ending December 31st; allnumbers 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.Question 1Based on the information given, prepare the normalization entries for the years 2010 – 2014.Explain your reasons for each normalization entry.Question 2Using 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. Thismakes 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. Thismakes it very difficult to print out)Question 3Compute the following ratios listed using the normalized data for each of the 5 years.Ratios to be calculated are:I. Growth Ratios1. Sales Growth Percentage2. Earnings GrowthPercentageII. Cost Control Ratios1. Cost of Sales/Sales2. Gross Margin or Profit3. Operating Expenses toSales4. Operating Margin or ProfitIndustry AverageN/AN/AN/A41.237.43.8III. Turnover Ratios1. Receivable Turnover2. Inventory Turnover101.73.5IV. Profitability Ratios1. Return on Assets2. Return on Equity7.416.8V. PercentageCurrent RatioInterest CoverageQuestion 4Tends: Analyzethe ratios you calculated for each of the 5 years. Analyze and explain why you believethey are indicative of issues (positive or negative) to your planned valuation ofGraham Products Inc.Question 5Using the normalized income statements developed above, estimate future income. State whyyou believe the method you selected for estimating future is the most appropriate for thiscompany.Question 6Based on the above exercises and a capitalization rate of 20%, calculate, using the interestcapitalization method, the value of Graham Products, IncInformation needed for normalization entriesYou have discovered the following information after reviewing the financialstatements and other company documents, and interviewing management.1.Net SalesDuring the period 2010 through 2014, the company has expanded theirproduct line and opened new stores. This caused the increase in salesduring this period. An analysis of the information shows the following:YearNumber of New Stores2011201222013220%020142.1Increase in Sales10%10%Cost of SalesProducts purchased from the same supplier. Different cost of salespercentages, due to different product lines.3.Salaries and WagesGenerally, the increase in salary expense was caused by hiring additionalemployees to work in the new stores. Included in the account, Officers’Compensation, is the salary of the owner, George Bigshot. His salary forthe 5 year period has been:2010 – $375,0002011 – $400,0002012 – $475,0002013 – $500,0002014 – $535,000You have compared his salary to industry data, and the amount hereceives appears to be high. His compensation appears to be 15% abovethe industry norm. June Bigshot is an employee and earns $35,000 peryear recorded in Other Salaries & Wages. From interviews and physicalobservation, it does not appear that she has any responsibilities and israrely at the business location. When Graham opened the last 2 stores in2014, they hired experienced managers. Each of these manager’s earn$5,000 more than the managers in the other stores, this amount appears tobe $3,000 above the norm in the industry.4.Selling ExpensesThis category includes numerous expense items. The Advertising andPromotion category is significantly higher in 2014 compared to previousyears. The marketing manager told you Graham redesigned all theirliterature in 2014. The cost of the design work and printing costs was$550,000.After careful analysis, you notice that the Travel and Entertainmentcategory has increased steadily since 2010. After asking questions, youdiscover personal trips that were paid for by the company. The annualamount 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 thecompany. The condo was acquired in 2010, and was capitalized as anInvestment on the Balance Sheet (see Investments below). The companyhas 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. Thestrike was settled and management does not anticipate any strikes in thefuture. 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 & AdministrativeThe insurance account has increased significantly. Most of the additionalcost is due to the opening of the new stores. However, there is $10,000 peryear of property insurance on the condo, and $12,500 per year of real estatetaxes 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 foreach of these stores is$48,000 per year, and the average rent for the other stores is $30,000 peryear. The use of office supplies appears to be very inconsistent. Theamount fluctuates greatly from year to year, but you could not find anyreason for this.In each year, that new stores were opened, the company took themaximum deduction for Section 179 expenses of $18,500. This amountis recorded in the Depreciation Section. Under normal circumstances theseassets would be depreciated over a 5 year period using straight linedepreciation.46.InvestmentsThe condominium was acquired in 2010 for $190,000. The condominiumwas depreciated on the straight line basis over 30 years, starting at thebeginning of 2010 with the land valued at $10,000. The balance in theInvestment account was reduced accordingly, instead of showingaccumulated depreciation and the depreciation expense was recorded inOther Expenses under the General & Administrative category. The balancein the Investment account represents stock that Mr. Bigshot trades on aregular basis. No gains or losses were incurred on these investments.7.DividendsDividends of $100,000 were paid in 2011.8.Advances from AffiliatesThis account represents funds borrowed from another company owned byMr. Bigshot. Graham pays a fair rate of interest on the funds borrowed.

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