Diamondz Corp. Diamondz Corp. manages recording artists, produces music, and rents out recording space to new and established musicians. The Dumais family members are the only shareholders. Marie and Bernard Dumais, who started the company in 1983, retired from active management in the company in 2010. They hold the preferred shares. Their children, Alexandra and André Dumais now run the business. Each holds 50% of the outstanding common shares. The company wants to open a recording studio in downtown Peterborough. Preliminary estimates indicate the cost of constructing the studio and installing state of the art recording equipment is $2,500,000. Alexandra and André need to look at options for financing this new venture. One option is to do an initial public offering (IPO) of shares in Diamondz Corp. You are the Chief Financial Officer (CFO) [and a non-family member] of Diamondz Corp. Alexandra and André have asked you to help with the analysis and decisions concerning the financing options. They run the creative side of the business and do not feel comfortable preparing the analysis. You attend a meeting with Alexandra (CEO) and André (President) on January 14, 2015. Required: Prepare a report for the CEO and President that discusses the current financial performance of Diamondz Corp. and addresses the financing options for the proposed recording studio. Financial Performance - you should include the following in your report: a. Cash Flow Statement for 2014 with 2013 comparative statement[Note: statements to be done on accounting paper and attached as an Appendix] b. Report to include an explanation of the role of the Cash Flow Statement and a discussion of Diamondz’s cash flow in 2013 and 2014 c. In anticipation of a possible IPO, Diamondz follows IFRS. Prepare a Statement of Changes in Equity for 2013 and 2014. [[Note: statement to be done on accounting paper] d. Calculate the following performance, liquidity and solvency measures for 2012, 2013, and 2014 to 1 decimal point. Comment on Diamondz’s performance over the period 2012-2014.. [Note: set up calculations in chart form on accounting paper] i. Profit Margin ii. EPS iii. Return on Equity (ROE) (calculate for 2014 and 2013) iv. Current ratio v. Debt-to-total assets vi. Times interest earned Financing Options for the proposed expansion - you should include the following in your report: a. A discussion of the advantages and disadvantages of financing the expansion with a debt issue or with an equity issue. [Note: must be typed, double-spaced] b. Discuss the impact, if any, on the existing shareholders of Diamondz and the impact on future financial performance of Diamondz for each option. For example, refer to the calculations you did and discuss the affect on some or all of those calculations. Are there other options in addition to a debt or equity issue? c. Your recommendation for a financing option Report: style, structure, content, spelling, grammar [10 marks]. [Note: report must be typed, doublespaced] Please include your student ID # and seminar section 2 Diamondz Corp. Statement of Financial Position At December 31, 2014 2013 2012 ASSETS Current Assets: Cash & Cash Equivalents $375,000 $320,000 $520,000 Accounts Receivable [net] 800,000 900,000 600,000 Inventory 200,000 300,000 100,000 Prepaid Expenses 50,000 80,000 60,000 Total Current Assets 1,425,000 1,600,000 1,280,000 Land 575,000 500,000 500,000 Building, net 1,480,000 1,600,000 1,580,000 Equipment, net 1,789,500 1,000,000 700,000 TOTAL ASSETS $5,269,500 $4,700,000 $4,060,000 LIABILITIES & SHAREHOLDERS’ EQUITY Accounts Payable 990,000 773,000 434,000 Accrued Liabilities 450,000 148,000 96,000 Unearned Revenue 118,000 160,000 120,000 Income Taxes Payable 250,000 219,000 270,000 Sales Taxes Payable 169,505 80,000 - Demand Bank Loan 119,000 120,000 100,000 Current Liabilities 2,096,505 $1,500,000 $1,020,000 Total Liabilities 2,096,505 1,500,000 1,020,000 Shareholders’ Equity: Preferred Shares, Series A, $2.40; 20,000 issued and outstanding 600,000 600,000 600,000 Common Shares, 100,000 issued and outstanding [note 2] 2,000,000 2,000,000 2,000,000 Retained Earnings 572,995 600,000 440,000 Total Shareholders’ Equity 3,172,995 3,200,000 3,040,000 TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY 5,269,500 $4,700,000 $4,060,000 The accompanying notes are an integral part of these Financial Statements [There is important information in the notes that you need to complete your analysis] 3 Diamondz Corp. Diamondz Corp. Income Statement For the years ended December 31, 2014 2013 2012 Recording and Production Fees $549,000 $630,000 $516,000 Management Fees 265,500 320,000 244,000 Studio Rental Fees 100,000 100,000 100,000 Total Revenue 914,500 1,050,000 860,000 Expenses: Depreciation 285,500 251,833 224,622 Salaries 210,000 182,000 165,000 Other Operating Expenses 132,855 127,367 141,578 Total Operating Expenses 628,355 561,200 531,200 Net Operating income before interest & taxes 286,145 488,800 328,800 Interest Expense 113,550 88,800 88,800 Net Income before taxes 172,595 400,000 240,000 Income Taxes [30%] 51,600 120,000 72,000 Net Income $120,995 $280,000 $168,000 The accompanying notes are an integral part of these Financial Statements Diamondz Corp. Diamondz Corp. Cash Flow Statement For the year ended December 31, 2013 Cash from Operations: Net Income $280,000 Adjustments for non-cash items: Add: Depreciation 251,833 Changes in non-cash current operating accounts Add: Increase in Accounts Payable 339,000 Increase in Accrued Liabilities 52,000 Increase in unearned revenue 40,000 Increase in Sales Taxes Payable 80,000 Less: Increase in Accounts Receivable (300,000) Increase in inventory (200,000) Increase in Prepaid Expenses (20,000) Decrease in Income Taxes Payable (51,000) Cash from Operations $471,833 Investing Activities Purchase of capital assets (571,833) Financing Activities Bank Loan proceeds 20,000 Dividend payments Preferred Shares (48,000) Common Shares (72,000) Cash inflow (outflow) from financing activities (100,000) Cash outflow for the year (200,000) Cash at the beginning of the year 520,000 Cash at the end of the year $320,000 The accompanying notes are an integral part of these Financial Statements Diamondz Corp. Note 1 – Summary of Significant Accounting Policies a. Diamondz Corp. is incorporated under the laws of Ontario. It follows International Financial Reporting Standards (IFRS). b. Revenue Recognition Deposits received for studio rentals are recognized on the date that the client uses the studio. Management Fee retainers are recognized in revenue over the life of the management contract. c. Cash & Cash Equivalents Cash and Cash Equivalents consist of cash on hand, bank balances, and money market investments with original maturities of three months or less. d. Provisions for Doubtful Accounts The provision for amounts due from clients is established based on an assessment of a client’s credit quality as well as subjective factors and trends, including the ageing of Accounts Receivable balances. e. Inventories Inventories relate to items commonly used in the studio such as blank disks and recording tapes. Inventories are valued at the lower of cost (calculated using the weighted-average cost formula) and net realizable value. The consumption of inventory is included in Other Operating Expenses. f. Land, Building & Equipment Building & Equipment are recorded at historical cost. They are depreciated on a straight-line basis over the estimated useful lives as follows: Buildings 40 years Computer Hardware 3 years Vehicles 5 years In 2014 Diamondz made a significant investment in computer hardware and software. They replaced the accounting software package and payroll processing software, upgraded all of the computer hardware and purchased the Blackberry Z10 for senior management. Total expenditures were $955,000. A vacant lot in downtown Peterborough became available in September 2014. Diamondz purchased this land for $75,000 with the intent of building the new recording studio on it. Diamondz Corp. g. Earnings per Share Basic earnings per share is calculated by dividing the net earnings available to common shareholders by the weighted average number of shares outstanding during the year. h. Accounting Estimates The preparation of financial statements in conformity with accounting principles generally accepted in Canada requires management to make assumptions and estimates. These estimates affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. These estimates and assumptions are based on management’s historical experience, best knowledge of current events and actions that the Company may undertake in the future. Significant areas requiring the use of management estimates relate to the determination of inventory valuation, goods and services tax, provincial sales tax and income tax provisions. By their nature, these estimates are subject to measurement uncertainty and the impact on the financial statements of future periods could differ materially from those estimated. Note 2 - Share Capital a. The $2.40 non-voting Cumulative First Preferred Shares, Series A, are entitled to fixed cumulative preferential cash dividends at the rate of $2.40 per share per annum. b. Stock Split On June 30, 2014 Diamondz issued a 2 for 1 split in the common shares. This had the effect of doubling the number of common shares issued and outstanding. c. Earnings per share Basic per share amounts are based on the weighted average number of shares outstanding. In 2014, the weighted average number of shares issued and outstanding was 75,000 shares. The weighted average number of common shares issued and outstanding in 2012 and 2013 was 50,000 Note 3 – Contingencies The company is party to various legal actions and complaints arising in the ordinary course of business. It is the opinion of the Company that the ultimate resolution of such matters will not materially affect the Company’s financial conditions or earnings.