MINICASE

S&S AIR GOES INTERNATIONAL

Mark Sexton and Todd Story, the owners of S&S Air, have been in discussions with a light
aircraft dealer in Monaco about selling the company’s planes in Europe. Jarek Jachowicz, the
dealer, wants to add S&S Air to his current retail line. Jarek has told Mark and Todd that he
feels the retail sales will be approximately €5.7 million per month. All sales will be made in
euros, and Jarek will retain 5 percent of retail sales as a commission, which will be paid in
euros. Because the planes will be customized to order, the first sales will take place in one
month. Jarek will pay S&S Air for the order 90 days after it is filled. This payment schedule
will continue for the length of the contract between the two companies.

Mark and Todd are confident the company can handle the extra volume with its existing
facilities, but they are unsure about the potential financial risks of selling their planes in
Europe. In their discussion with Jarek, they found that the current exchange rate is $1.09/€.
At the current exchange rate, the company would spend 80 percent of the sales on production
costs. This number does not reflect the sales commission paid to Jarek.

Mark and Todd have decided to ask Chris Guthrie, the company’s financial analyst, to prepare
an analysis of the proposed international sales. Specifically, they ask Chris to answer the
following questions.

QUESTIONS

1. What are the pros and cons of the international sales? What additional risks will the
company face?
2. What happens to the company’s profits if the dollar strengthens? What if the dollar
weakens?
3. Ignoring taxes, what are S&S Air’s projected gains or losses from this proposed
arrangement at the current exchange rate of $1.09/€? What happens to profits if the
exchange rate changes to $1.03/€? At what exchange rate will the company break even?
4. How could the company hedge its exchange rate risk? What are the implications for this
approach?
5. Taking all factors into account, should the company pursue the international sales
further? Why or why not?
MINICASE
PLANNING FOR GROWTH AT S&S AIR
After Chris completed the ratio analysis for S&S Air (see Chapter 3), Mark and Todd
approached him about planning for next year’s sales. The company had historically used little
planning for investment needs. As a result, the company experienced some challenging times
because of cash flow problems. The lack of planning resulted in missed sales, as well as
periods when Mark and Todd were unable to draw salaries. To this end, they would like Chris
to prepare a financial plan for the next year so the company can begin to address any outside
investment requirements. The income statement and balance sheet are shown here:

S&S Air, Inc.

2018 Income Statement
Sales   $46,298,115
Cost of goods sold   34,536,913
Other expenses   5,870,865
Depreciation       2,074,853
EBIT   $  3,815,484
Interest          725,098
Taxable income   $  3,090,386
Taxes (21%)          772,597
Net income   $  2,317,789
    Dividends $   705,000  
    Add to retained earnings  1,612,789  
 S&S Air, Inc.
2018 Balance Sheet
Assets   Liabilities and Equity
Current assets     Current liabilities  
Cash $     524,963   Accounts payable $  1,068,356
Accounts receivable       843,094   Notes payable     2,439,553
Inventory     1,235,161   Total current $  3,507,909
liabilities
Total current assets $  2,603,218   Long-term debt $  6,300,000
Fixed assets        
Net plant and $20,381,945  
equipment Shareholder equity
 Common stock
$     460,000
      Retained earnings   12,717,254
      Total equity $13,177,254
Total assets $22,985,163   Total liabilities and equity $22,985,163
QUESTIONS

1. Calculate the internal growth rate and sustainable growth rate for S&S Air. What do these
numbers mean?
2. S&S Air is planning for a growth rate of 12 percent next year. Calculate the EFN for the
company assuming the company is operating at full capacity. Can the company’s sales
increase at this growth rate?
3. Most assets can be increased as a percentage of sales. For instance, cash can be increased
by any amount. However, fixed assets must be increased in specific amounts because it is
impossible, as a practical matter, to buy part of a new plant or machine. In this case, a
company has a “staircase” or “lumpy” fixed cost structure. Assume S&S Air is currently
producing at 100 percent capacity. As a result, to increase production, the company must
set up an entirely new line at a cost of $5,000,000. Calculate the new EFN with this
assumption. What does this imply about capacity utilization for the company next year?
MINICASE
THE BIRDIE GOLF–HYBRID GOLF MERGER
Birdie Golf, Inc., has been in merger talks with Hybrid Golf Company for the past six months.
After several rounds of negotiations, the offer under discussion is a cash offer of $185 million
for Hybrid Golf. Both companies have niche markets in the golf club industry, and both
believe that a merger will result in synergies due to economies of scale in manufacturing and
marketing, as well as significant savings in general and administrative expenses.

Bryce Bichon, the financial officer for Birdie, has been instrumental in the merger
negotiations. Bryce has prepared the following pro forma financial statements for Hybrid Golf
assuming the merger takes place. The financial statements include all synergistic benefits
from the merger.

2019 2020 2021 2022 2023

Sales $330,000,00 $375,000,00 $415,000,00 $445,000,00 $495,000,0
Productio 0 0 0 0 00
n costs 231,000,000 262,500,000 290,500,000 311,500,000 346,500,00
Other 33,000,000 38,000,000 41,000,000 45,000,000 0
expenses             49,000,000
Depreciati 27,000,000 31,000,000 33,000,000 36,000,000   
on $ $ $ $ 36,000,000
EBIT 39,000,000 43,500,000 50,500,000 52,500,000 $  63,500,0
Interest               00

Taxable 7,500,000 9,000,000 10,000,000 10,500,000   

income $ $  $ $ 11,000,000

Taxes 31,500,000 34,500,000 40,500,000 42,000,000 $

(21%)                 52,500,000

Net 6.615,000 7,245,000 8,505,000 8,820,000   

income $  $ $ $ 11,025,000

Additions 24,885,000 27,255,000 31,995,000 33,180,000 $

to 0 $ $ $ 41,475,000
retained 16,000,000 19,000,000 21,000,000 $
earnings 25,000,000
If Birdie Golf buys Hybrid Golf, an immediate dividend of $55 million would be paid from
Hybrid Golf to Birdie. Stock in Birdie Golf currently sells for $87 per share, and the company
has 18 million shares of stock outstanding. Hybrid Golf has 8 million shares of stock
outstanding. Both companies can borrow at an 8 percent interest rate. Bryce believes the
current cost of capital for Birdie Golf is 11 percent. The cost of capital for Hybrid Golf is 12.4
percent, and the cost of equity is 16.9 percent. In five years, the value of Hybrid Golf is
expected to be $235 million.

Bryce has asked you to analyze the financial aspects of the potential merger. Specifically, he
has asked you to answer the following questions.
QUESTIONS

1. Suppose Hybrid shareholders will agree to a merger price of $23.13 per share. Should
Birdie proceed with the merger?
2. What is the highest price per share that Birdie should be willing to pay for Hybrid?
3. Suppose Birdie is unwilling to pay cash for the merger but will consider a stock exchange.
What exchange ratio would make the merger terms equivalent to the original merger
price of $23.13 per share?
4. What is the highest exchange ratio Birdie should be willing to pay and still undertake the
merger?
Brahim’s board says PwC resigned
after mutual agreement
Arjuna Chandran Shankar/The Edge Financial Daily

December 17, 2019 09:18 am +08

This article first appeared in The Edge Financial Daily, on December 17, 2019.

KUALA LUMPUR: Brahim’s Holdings Bhd, whose shares dived after it

announced PricewaterhouseCoopers PLT (PwC) had voluntarily resigned as
its external auditor with immediate effect, said yesterday PwC’s departure is
partly due to Brahim’s board’s view that a change of auditors would be good
for corporate governance.

“PwC has been Brahim’s SATS Food Services Sdn Bhd’s (BSFS) auditor for
more than 15 years. BSFS contributes more than 90% of the group’s
revenue. As part of an ongoing good corporate governance initiative,
Brahim’s and BSFS’ boards viewed that it would be timely to effect a change
of auditors.

“Changing auditors also enables the company to benefit from fresh

perspectives and views of another professional audit firm, thus enhancing
the value of the audit of the group. On Nov 21, 2019, BSFS, at its board of
directors meeting, agreed to change auditors, subject to relevant
formalities,” Brahim’s said in a filing with Bursa Malaysia.
It said PwC’s resignation, which it announced last Thursday, was after a
mutual agreement between the parties based on the aforementioned, and
that the board is actively pursuing the formalisation and implementation of a
regularisation plan, aiming to exit its Practice Note 17 (PN17) status.

“The regularisation plan requires appointing reporting accountants to carry

out in-depth financial review and reports. The board believes it would be
expedient to have [it be] the same party as the company and the group’s
auditor,” Brahim’s said.

It concluded the statement by assuring shareholders that changing auditors

— Messrs Baker Tilly Monteiro Heng PLT replaces PwC as Brahim’s new
auditor for the current financial year ending Dec 31, 2019 (FY19) — is in the
ordinary course of business and in the company and the group’s best
interest.

Brahim’s statement was issued in response to The Edge Malaysia’s weekly

article entitled “Tell Investors Why” published in the Dec 16 to 22 issue,
which noted that investors appeared spooked by PwC’s sudden resignation,
given a steep fall in Brahim’s shares following the announcement.

Brahim’s shares closed at 21 sen apiece, down two sen from last Friday, with
a market capitalisation of RM50.8 million.

The group has lost 24% or RM17.7 million in market capitalisation since it
revealed PwC’s resignation last Thursday. At the time, it offered no reasons
for the resignation, which came seven months after PwC’s reappointment as
its auditor in the annual general meeting on May 4 for FY19