You have to be the chief Software Engineer, and your mission is to describe functional and non-functional requirements, as good and detailed as possible. When you are missing data, you have to make assumptions (sometimes wild ones). No one can really answer your questions, and you have a presentation to the higher management in 45 min sharp. By then, you have to construct a document, with a very small ( no more than 10 lines) executive description, and no more than two A4 pages (1.25 space, font 12) text. Good luck.

INFORMATION ABOUT THE PROJECT

Our company is seriously considering of bidding for the following project, and we ask you, the lead Software Engineer, to construct a draft document, with the functional and non-functional requirements. The better your document, the better job will do our business development team to construct a proposal.

Project abstract description

The project is about monitoring the two gates of the University, automate the entry of authorized personnel, plus record all car license plates, if they left at night, and also raise alarms if a car is in the parking for more than 5 days. Also the system needs to report cars that are still at the parking, or during any holiday, or when the University is closed officially (e.g., during summer holidays). During those periods, only high-ranking personnel is automatically allowed to enter (e.g., Deans). All others need to be stopped at the gate, and call their supervisor. For that purpose, the following descriptions have been gathered.

Notes

• Each security room next to each gate, will be equipped with the necessary hardware, in order for the guards to see the license plate camera, plus another camera facing the car driver. Also each car will be equipped with electronic id device. The entry bar will be connected to the system, and will be automatically raised, if the car and driver are both authorized.

• The license plate cameras have to have a good false positive rate. The driver-side camera will not do face recognition at the beginning, but the client wants this to be an option for the near future.

• The time it takes for one car to enter, is of great importance. The client needs to know this in detail.

• There should be a “manual override” button on the screen, but the system should keep all details possible, guard details, time, date, car & license picture, etc.

• The client will accommodate all data into their own facilities and infrastructure, but they will not provide any hardware/software for this project.

• The guards will be trained accordingly if desired.

• The data gathered should not be used for other purposes.

• The staff, students, faculty, are really worried about their personal data, and how those

  are going to be used. Some even claim that the data will be used to monitor their

  working time.

• Our company, is worried about the cost of this project, and we want to find innovative

  ways to keep the cost low, so we can bid a lower price, and get a competitive advantage

  against other bidders.

• Our company also is not very experienced in such projects, and they hired you to “make

the difference”.

be the chief Software Engineer, and your mission is to describe functional and non-functional requirements, as good and detailed as possible. When you are missing data, you have to make assumptions (sometimes wild ones). No one can really answer your questions, and you have a presentation to the higher management in 45 min sharp. By then, you have to construct a document, with a very small ( no more than 10 lines) executive description, and no more than two A4 pages (1.25 space, font 12) text. Good luck.

INFORMATION ABOUT THE PROJECT

Our company is seriously considering of bidding for the following project, and we ask you, the lead Software Engineer, to construct a draft document, with the functional and non-functional requirements. The better your document, the better job will do our business development team to construct a proposal.

Project abstract description

The project is about monitoring the two gates of the University, automate the entry of authorized personnel, plus record all car license plates, if they left at night, and also raise alarms if a car is in the parking for more than 5 days. Also the system needs to report cars that are still at the parking, or during any holiday, or when the University is closed officially (e.g., during summer holidays). During those periods, only high-ranking personnel is automatically allowed to enter (e.g., Deans). All others need to be stopped at the gate, and call their supervisor. For that purpose, the following descriptions have been gathered.

Notes

• Each security room next to each gate, will be equipped with the necessary hardware, in order for the guards to see the license plate camera, plus another camera facing the car driver. Also each car will be equipped with electronic id device. The entry bar will be connected to the system, and will be automatically raised, if the car and driver are both authorized.

• The license plate cameras have to have a good false positive rate. The driver-side camera will not do face recognition at the beginning, but the client wants this to be an option for the near future.

• The time it takes for one car to enter, is of great importance. The client needs to know this in detail.

• There should be a “manual override” button on the screen, but the system should keep all details possible, guard details, time, date, car & license picture, etc.

• The client will accommodate all data into their own facilities and infrastructure, but they will not provide any hardware/software for this project.

• The guards will be trained accordingly if desired.

• The data gathered should not be used for other purposes.

• The staff, students, faculty, are really worried about their personal data, and how those

  are going to be used. Some even claim that the data will be used to monitor their

  working time.

• Our company, is worried about the cost of this project, and we want to find innovative

  ways to keep the cost low, so we can bid a lower price, and get a competitive advantage

  against other bidders.

• Our company also is not very experienced in such projects, and they hired you to “make

the difference”.

ATC 14-1 Business Applications Case Preparing and using pro forma statements

Maria Gutierrez and Devin Duzan recently graduated from the same university. After graduation they decided not to seek jobs at established organizations but, rather, to start their own small business hoping they could have more flexibility in their personal lives for a few years. Maria’s family has operated Mexican restaurants and taco trucks for the past two generations, and Maria noticed there were no taco truck services in the town where their university was located. To reduce the amount, they would need for an initial investment, they decided to start a business operating a taco cart rather than a taco truck, from which they would cook and serve traditional Mexican-styled street food.

They bought a used taco cart for $25,000. This cost, along with the cost for supplies to get started, a business license, and street vendor license brought their initial expenditures to $29,000. They took $5,000 from personal savings they had accumulated by working part-time during college, and they borrowed $15,000 from Maria’s parents. They agreed to pay interest on the outstanding loan balance each month based on an annual rate of 4 percent. They will repay the principal over the next few years as cash becomes available. They were able to rent space in a parking lot near the campus they had attended, believing that the students would welcome their food as an alternative to the typical fast food that was currently available.

After two months in business, September and October, they had average monthly revenues of $20,000 and out-of-pocket costs of $16,000 for rent, ingredients, paper supplies, and so on, but not interest. Devin thinks they should repay some of the money they borrowed, but Maria thinks they should prepare a set of forecasted financial statements for their first year in business before deciding whether or not to repay any principal on the loan. She remembers a bit about budgeting from a survey of accounting course she took and thinks the results from their first two months in business can be extended over the next 10 months to prepare the budget they need. They estimate the cart will last at least five years, after which they expect to sell it for $5,000 and move on to something else in their lives. Maria agrees to prepare a forecasted (pro forma) income statement, balance sheet, and statement of cash flows for their first year in business, which includes the two months already passed.

Required

1. Prepare the annual pro forma financial statements that you would expect Maria to prepare based on her comments about her expectations for the business. Assume no principal will be repaid on the loan. [Note: Some amounts are different from the printed text version]

2. Review the statements you prepared for the first requirement and prepare a list of reasons why actual results for Devin and Maria’s business probably will not match their budgeted statements.

Cape Fear Marine Mini Case

Sarah Connor was recently hired by Cape Fear Marine Company to assist the company with its short-term financial planning and to evaluate the firm’s financial performance. Sarah graduated from college five years ago with a degree in finance and had been employed in the treasury department of a large firm in Raleigh, North Carolina since then.

Kyle Reese founded Cape Fear Marine Company 15 years ago. The company’s operations are located near Wilmington, North Carolina. The firm is structured as an LLC. Cape Fear Marine manufactures a diverse line of boats, ranging from low-end fishing boats to high-end luxury craft. The company and its products have received high reviews for safety and reliability, as well as awards for customer satisfaction.

The marine products/boating industry is fragmented, with a number of manufacturers. As with any industry, there are market leaders, but the diverse nature of the industry ensures that no manufacturer dominates the market. The competition in the market, as well as the product cost, ensures that attention to detail is a necessity.

To get Sarah started with her analysis, Kyle has provided the following financial data. Sarah has gathered the industry ratios for the boat manufacturing industry.

a.   Calculate all of the ratios listed in the industry table for Cape Fear Marine.

b.   Compare the performance of Cape Fear Marine with the industry as a whole. For each ratio, comment on why it might be viewed as a positive or negative relative to the industry.

Sharpton Fabricators Corporation manufactures a variety of parts for the automotive industry. The company uses a job-order costing system with a plantwide predetermined overhead rate based on direct labour-hours. On December 10, 2015, the company’s controller made a preliminary estimate of the predetermined overhead rate for 2016. The new rate was based on the estimated total manufacturing overhead cost of $3,402,000 and the estimated 63,000 total direct labour-hours for 2016:

Predetermined overhead rate = 3,402,000/63,000 = $54 per direct labour hours

This new predetermined overhead rate was communicated to top managers in a meeting on December 11. The rate did not cause any comment because it was within a few cents of the overhead rate that had Page 190been used during 2015. One of the subjects discussed at the meeting was a proposal by the production manager to purchase an automated milling machine centre built by Central Robotics. The president of Sharpton Fabricators, Kevin Reynolds, agreed to meet with the regional sales representative from Central Robotics to discuss the proposal.

On the day following the meeting, Reynolds met with Jay Warner, Central Robotics’ sales representative. The following discussion took place:

1. Reynolds: Lisa Winter, our production manager, asked me to meet with you since she’s interested in installing an automated milling machine centre. Frankly, I’m skeptical. You’re going to have to show me this isn’t just another expensive toy for Lisa’s people to play with.

2. Warner: That shouldn’t be too difficult, Kevin. The automated milling machine centre has three major advantages. First, it’s much faster than the manual methods you’re using. It can process about twice as many parts per hour as your current milling machines. Second, it’s much more flexible. There are some up-front programming costs, but once those have been incurred, almost no setup is required on the machines for standard operations. You just punch in the code of the standard operation, load the machine’s hopper with raw material, and the machine does the rest.

3. Reynolds: Yeah, but what about cost? Having twice the capacity in the milling machine area won’t do us much good. That centre is idle much of the time, anyway.

4. Warner: I was getting there. The third advantage of the automated milling machine centre is lower cost. Winters and I looked over your present operations, and we estimated that the automated equipment would eliminate the need for about 6,000 direct labour-hours a year. What is your direct labour cost per hour?

5. Reynolds: The wage rate in the milling area averages about $32 per hour. Fringe benefits raise that figure to about $41 per hour.

6. Warner: Don’t forget your overhead.

7. Reynolds: Next year the overhead rate will be about $54 per direct labour-hour.

8. Warner: So including fringe benefits and overhead, the cost per direct labour-hour is about $95.

9. Reynolds: That’s right.

10. Warner: Since you can save 6,000 direct labour-hours per year, the cost savings would amount to about $570,000 a year, and our 60-month lease plan would require payments of only $348,000 per year.

11. Reynolds: Sold! When can you install the equipment?

Shortly after this meeting, Reynolds informed the company’s controller of the decision to lease the new equipment, which would be installed over the Christmas vacation period. The controller realized that this decision would require a recomputation of the predetermined overhead rate for 2016, since the decision would affect both the manufacturing overhead and the direct labour-hours for the year. After talking with both the production manager and the sales representative from Central Robotics, the controller discovered that in addition to the annual lease cost of $348,000, the new machine would also require a skilled technician/programmer who would have to be hired at a cost of $50,000 per year to maintain and program the equipment. Both of these costs would be included in factory overhead. There would be no other changes in total manufacturing overhead cost, which is almost entirely fixed. The controller assumed that the new machine would result in a reduction of 6,000 direct labour-hours for the year from the levels that had initially been planned.

When the revised predetermined overhead rate for 2016 was circulated among the company’s top managers, there was considerable dismay.

Required:

1. Recompute the predetermined rate assuming that the new machine will be installed. Explain why the new predetermined overhead rate is higher (or lower) than the rate that was originally estimated for 2016.

2. What effect (if any) would this new rate have on the cost of jobs that do not use the new automated milling machine?

3. Why would managers be concerned about the new overhead rate?

4. After seeing the new predetermined overhead rate, the production manager admitted that he probably wouldn’t be able to eliminate all of the 6,000 direct labour-hours. He had been hoping to accomplish the reduction by not replacing workers who retire or quit, but that would not be possible. As a result, the real labour savings would only be about 2,000 hours—one worker. In the light of this additional information, evaluate the original decision to acquire the automated milling machine from Central Robotics.

Sharpton Fabricators Corporation manufactures a variety of parts for the automotive industry. The company uses a job-order costing system with a plantwide predetermined overhead rate based on direct labor-hours. On December 10, 2015, the company's controller made a preliminary estimate of the predetermined overhead rate for 2016. The new rate was based on the estimated total manufacturing overhead cost of $3,402,000 and the estimated 63,000 total direct labor-hours for 2016:

            Predetermined overhead rate = $2,475,000/52,000 hours

                                                           = $47.60 per direct labor-hour.

This new predetermined overhead rate was communicated to top managers in a meeting on December11. The rate did not cause any comment because it was within a few cents of the overhead rate that had been used during 2015. One of the subjects discussed at the meeting was a proposal by the production manager to purchase an automated milling machine center built by Central Robotics. The president of Sharpton Fabricators, Kevin Reynolds, agreed to meet with the regional sales representative from Central Robotics to discuss the proposal.

On the day following the meeting, Reynolds met with Jay Warner, Central Robotics’ sales representative. The following discussion took place:

Reynolds: Lisa Winter, our production manager, asked me to meet with you since she's interested in installing an automated milling machine center. Frankly, I’m skeptical. You’re going to have to show me this isn’t just another expensive toy for Lisa's people to play with.

Warner: That shouldn’t be too difficult, Kevin. The automated milling machine center has three major advantages. First, it's much faster than the manual methods you’re using. It can process about twice as many parts per hour as your current milling machines. Second, it's much more flexible. There are some up-front programming costs, but once those have been incurred, almost no setup is required on the machines for standard operations. You just punch in the code of the standard operation, load the machine's hopper with raw material, and the machine does the rest.

Reynolds: Yeah, but what about cost? Having twice the capacity in the milling machine area won’t do us much good. That center is idle much of the time, anyway.

Warner: I was getting there. The third advantage of the automated milling machine center is lower cost. Winters and I looked over your present operations, and we estimated that the automated equipment would eliminate the need for about 6,000 direct labor-hours a year. What is your direct labor cost per hour?

Reynolds: The wage rate in the milling area averages about $32 per hour. Fringe benefits raise that figure to about $41 per hour.

Warner: Don’t forget your overhead.

Reynolds: Next year the overhead rate will be about $54 per direct labor-hour.

Warner: So, including fringe benefits and overhead, the cost per direct labor-hour is about $95.

Reynolds: That's right.

Warner: Since you can save 6,000 direct labor-hours per year, the cost savings would amount to about$570,000 a year, and our 60-month lease plan would require payments of only $348,000 per year.

Reynolds: Sold! When can you install the equipment?

Shortly after this meeting, Reynolds informed the company's controller of the decision to lease the new equipment, which would be installed over the Christmas vacation period. The controller realized that this decision would require a recomputation of the predetermined overhead rate for 2016, since the decision would affect both the manufacturing overhead and the direct labor-hours for the year. After talking with both the production manager and the sales representative from Central Robotics, the controller discovered that in addition to the annual lease cost of $348,000, the new machine would also require as killed technician/programmer who would have to be hired at a cost of $50,000 per year to maintain and program the equipment. Both of these costs would be included in factory overhead. There would be no

other changes in total manufacturing overhead cost, which is almost entirely fixed. The controller assumed that the new machine would result in a reduction of 6,000 direct labor-hours for the year from the levels that had initially been planned.

When the revised predetermined overhead rate for 2016 was circulated among the company's top managers, there was considerable dismay.

Required:

Recompute the predetermined rate assuming that the new machine will be installed. Explain why the new predetermined overhead rate is higher (or lower) than the rate that was originally estimated for 2016.

What effect (if any) would this new rate have on the cost of jobs that do not use the new automated milling machine?

Why would managers be concerned about the new overhead rate?

After seeing the new predetermined overhead rate, the production manager admitted that he probably wouldn’t be able to eliminate all of the 6,000-direct labor-hours. He had been hoping to accomplish the reduction by not replacing workers who retire or quit, but that would not be possible. As a result, the real labor savings would only be about 2,000 hours—one worker. In the light of this additional information, evaluate the original decision to acquire the automated milling machine from Central Robotics.

THE BUSINESS SITUATION

                When Shelley Jones became president-elect of the Circular Club of Auburn, Kansas,

she was asked to suggest a new fundraising activity for the club. After a considerable

amount of research, Shelley proposed that the Circular Club sponsor a professional

rodeo. In her presentation to the club, Shelley said that she wanted a

fundraiser that would (1) continue to get better each year, (2) give back to the community,

and (3) provide the club a presence in the community. Shelley’s goal was to

have an activity that would become an “annual community event” and that would

break even the first year and raise $5,000 the following year. In addition, based on

the experience of other communities, Shelley believed that a rodeo could grow in

popularity so that the club would eventually earn an average of $20,000 annually.

                A rodeo committee was formed. Shelley contacted the world’s oldest and

largest rodeo-sanctioning agency to apply to sponsor a professional rodeo. The

sanctioning agency requires a rodeo to consist of the following five events:

Bareback Riding, Bronco Riding, Steer Wrestling, Bull Riding, and Calf Roping.

Because there were a number of team ropers in the area and because they

wanted to include females in the competition, members of the rodeo committee

added Team Roping and Women’s Barrels. Prize money of $3,000 would be paid

to winners in each of the seven events.

                Members of the rodeo committee contracted with RJ Cattle Company, a livestock

contractor on the rodeo circuit, to provide bucking stock, fencing, and

chutes. Realizing that costs associated with the rodeo were tremendous and that

ticket sales would probably not be sufficient to cover the costs, the rodeo committee

sent letters to local businesses soliciting contributions in exchange for

various sponsorships. Exhibiting Sponsors would contribute $1,000 to exhibit

their products or services, while Major Sponsors would contribute $600. Chute

Sponsors would contribute $500 to have the name of their business on one of the

six bucking chutes. For a contribution of $100, individuals would be included in

a Friends of Rodeo list found in the rodeo programs. At each performance the

rodeo announcer would repeatedly mention the names of the businesses and individuals

at each level of sponsorship. In addition, large signs and banners with

the names of the businesses of the Exhibiting Sponsors, Major Sponsors, and

Chute Sponsors were to be displayed prominently in the arena.

CaseA local youth group was contacted to provide concessions to the public and

divide the profits with the Circular Club. The Auburn Circular Club Pro Rodeo

Roundup would be held on June 1, 2, and 3. The cost of an adult ticket was set

at $8 in advance or $10 at the gate; the cost of a ticket for a child 12 or younger

was set at $6 in advance or $8 at the gate. Tickets were not date-specific. Rather,

one ticket would admit an individual to one performance of his or her choice—

Friday, Saturday, or Sunday. The rodeo committee was able to secure a location

through the county supervisors board at a nominal cost to the Circular Club. The

arrangement allowed the use of the county fair grounds and arena for a oneweek

period. Several months prior to the rodeo, members of the rodeo committee

had been assured that bleachers at the arena would hold 2,500 patrons. On

Saturday night, paid attendance was 1,663, but all seats were filled due to poor

gate controls. Attendance was 898 Friday and 769 on Sunday.

                The following revenue and expense figures relate to the first year of the rodeo.

Receipts

Contributions from sponsors $22,000

Receipts from ticket sales 28,971

Share of concession profits 1,513

Sale of programs 600

Total receipts $53,084

Expenses

Livestock contractor 26,000

Prize money 21,000

Contestant hospitality 3,341*

Sponsor signs for arena 1,900

Insurance 1,800

Ticket printing 1,050

Sanctioning fees 925

Entertainment 859

Judging fees 750

Port-a-potties 716

Rent 600

Hay for horses 538

Programs 500

Western hats to first 500 children 450

Hotel rooms for stock contractor 325

Utilities 300

Sand for arena 251

Miscellaneous fixed costs 105

Total expenses 61,410

Net loss $(8,326)

*The club contracted with a local caterer to provide a tent and food for the contestants. The

cost of the food was contingent on the number of contestants each evening. Information concerning

the number of contestants and the costs incurred are as follows:

Contestants Total Cost

Friday 68 $ 998

Saturday 96 1,243

Sunday 83 1,100

$3,341

On Wednesday after the rodeo, members of the rodeo committee met to

Discuss and critique the rodeo. Jonathan Edmunds, CPA and President of the

Circular Club, commented that the club did not lose money. Rather, Jonathan

said, “The club made an investment in the rodeo.”

Answer Questions Below

1. Do yo think it was necessary for shelly joes to stipulate that she (1) wanted a fundraiser that world continue to get better each year (2) give back to the community and (3) provide the club a presence in the community? Why or why not?

2. What did Johnathan Edmunds mean when he said the club had made an invstment in the rodeo?

5. Determine the fixed and variable cost components of the catering costs using the high low method?

When WorldCom Inc.’s former chief executive Bernard Ebbers was found guilty of participating

In one of the largest U.S. accounting frauds ever, the ruling sent a message to corporate

Executives: Professing ignorance won’t necessarily save you.

Mr. Ebbers, who died Feb. 2 at age 78, was a former gym teacher who rose to head a

Telecommunications Company with a peak market value of about $180 billion. In the late 1990s

And early 2000s, WorldCom improperly boosted profit by booking operating expenses as capital

Spending, which can be deducted from earnings in small chunks over time.

During a trial in 2005, he pleaded not guilty to accounting fraud and said he didn’t know about

The misdeeds. The jury didn’t buy it. His 25-year prison sentence “put an exclamation point behind the old phrase ‘the buck stops here,’ ” said Patrick McGurn, special counsel at proxy advisor Institutional Shareholder Services. The dot-com bust and accounting scandals at WorldCom and Enron Corp. helped spur Congress to enact the Sarbanes-Oxley Act of 2002, whose provisions include requiring a public company’s chief executive and chief financial officer to certify that financial statements are accurate. The scandals also hastened a trend toward more independent corporate directors willing to challenge CEOs. Charles Elson, who heads a corporate-governance center at the University of Delaware, has this epitaph for the WorldCom fiasco: “As bad as it was, some good came out of it.” The regulatory changes didn’t mean corporate scandals would automatically land CEOs in prison. The aftermath of the 2008 financial crisis was notable for a lack of CEO scalps. Corporate leaders, wary of prison, may have become more cautious and less likely to leave paper or email trails, said Peter Henning, a law professor at Wayne State University, in Detroit. Mr. Ebbers, who built WorldCom through dozens of takeovers, was released from prison 13 years into his sentence in December because of deteriorating health. He followed an unconventional route to the CEO suite. The second of five children, Bernard John Ebbers was born Aug. 27, 1941, in Edmonton, Alberta, in Canada. His father worked as a traveling salesman and mechanic. The family moved to California in the late 1940s. Mr. Ebbers attended a boarding school on a Navajo reservation in New Mexico. As a young man he held odd jobs as a milk delivery man and a nightclub bouncer. Twice he gave up on college because of poor grades. He graduated from Mississippi College, where he played basketball, with a degree in education in 1967. Early in his career, Mr. Ebbers taught physical education and worked in a garment factory. He later began buying motels, starting with one in Columbia, Miss., where he lived in a two bedroom trailer in the parking lot. When AT&T’s “Ma Bell” system was broken up in the early 1980s, small rivals began reselling long-distance service. Mr. Ebbers and a handful of investors backed a company called Long Distance Discount Service, later renamed WorldCom. Dubbed the “Telecom Cowboy,” he earned a reputation as a hard-driving boss. He began to borrow money from the company in the late 1990s and used some of it to buy company stock. As the company expanded, Mr. Ebbers said he relied heavily on experts. “I’m not an engineer by training; I’m not an accountant by training,” he told the New York Times in 1998. “I’m the coach. I’m not the point guard who shoots the ball.” WorldCom began to show signs of stress in 2000 as its share price sank amid the dot-com meltdown. Mr. Ebbers was fired as CEO in April 2002. Soon afterward, an internal auditor spotted accounting irregularities. After his ouster, Mr. Ebbers appeared at his Mississippi church. At the end of the service, he walked to the front of the church and spoke to the congregation: “I just want you to know you aren’t going to church with a crook.” WorldCom’s former chief financial officer, Scott Sullivan, who engineered the fraud and worked closely with Mr. Ebbers, was sentenced to five years in prison after cooperating with prosecutors. He testified that Mr. Ebbers knew of the accounting methods used. Mr. Ebbers insisted he was blind-sided by the fraud. “I know what I don’t know,” he testified in a federal court. “I don’t, to this day, know technology. I don’t know finance and accounting.” As a judge delivered the sentence in 2005, Mr. Ebbers hung his head and cried while hugging his wife, Kristie Ebbers, who filed for divorce in 2008. He drove himself to prison in a Mercedes the following year and spent part of his sentence as inmate No. 56022-054 in a low-security prison in Louisiana. He was later transferred to FMC Fort Worth, a federal prison hospital in Texas. Paul Watson, a Mississippi resident and former WorldCom investor, lost $135,000 when the company collapsed, and supports a relative who lost $2.2 million. Still, he said, he feels little anger toward Mr. Ebbers and thinks “others have done far worse and been punished less.”

1. Why do you think, Charles Elson, from University of Delaware, said: “As bad as it was, some good came out of it.”?
2. Do you believe Mr. Ebbers was at fault of what happened with Worldcom despite he claimed in court that”…. I don’t know finance and accounting.” Why?
3. Why was Bernie Ebbers called the Telecom Cowboy?
4. Did the agency problem take a role in the Worldcom fiasco? Explain why yes or no? (note: there is not a clear answer here, so whatever you answer will be ok as long as you can explain it)

Heavy Keele Ltd. (HK) has a long-standing reputation as a manufacturer of quality sailboats. HK currently produces two different models of sailboat from a single production facility — the HK41 and the HK49. The past several years have seen a 25% decline in demand for HK’s sailboats and a significant increase in interest within the boating community for motor vessels. Given this shift in attitudes, HK is now considering a proposal to introduce a motor vessel into its product line — the HKMV55.

If the proposal is accepted, senior management has decided to restructure the firm into two separate divisions for operational purposes — the Sailboat division and the Motor Vessel division. Under the proposal, all current personnel will remain with the Sailboat division and the senior management team will remain unchanged. For accounting purposes, however, the $2 million annual cost of the senior management team will be allocated equally between the two divisions. HK will then seek an entire new management team to oversee the Motor Vessel division. Management has also decided that the new division should operate out of its own production facility. It can be built on the block of land adjacent to the current facility that HK already owns.

Senior management has decided that the appropriate planning horizon for the proposed new Motor Vessel division is 10 years. You work in the controller’s office of HK and have been asked to perform a series of analyses on this proposal. To facilitate your analysis, you have been provided with the Motor Vessel division’s projected income statements over the next 10 years, as well as the following information.

Capital expenditures

• The block of land on which the new production facility will be built was purchased by HK three years ago at a cost of $2.5 million. It has a current market value of $3 million, and it is expected that the value of the land will remain at $3 million when the project is complete.

• Management expects that the production facility will cost $10 million to build. It has an estimated useful life of 20 years and will be depreciated on a straight-line basis to an estimated salvage value of $1 million for accounting purposes. It belongs to an asset class with a CCA rate of 7.5%. At the end of the 10-year planning horizon, the facility will have an estimated market value of $3 million. The building qualifies for the Accelerated Investment Incentive, and 1.5 times the CCA can be taken in the year of acquisition. At the end of the planning horizon, assume that there is still a positive balance remaining in the class after the deduction of the proceeds.

• The new equipment required for the production of the HKMV55 will cost $7 million and has an estimated useful life of 10 years. For accounting purposes, this equipment will also be depreciated on a straight-line basis. It belongs to an asset class with a CCA rate of 10% and has an estimated salvage value of $500,000 at the end of its useful life. The equipment qualifies for the Accelerated Investment Incentive, and 1.5 times the CCA can be taken in the year of acquisition. At the end Corporate Finance Project Details 2 / 3 of the planning horizon, assume that there is still a positive balance remaining in the class after the deduction of the proceeds.

• The new Motor Vessel division requires an initial investment in net working capital of $750,000.

Operating revenues and expenses, and working capital accounts

• Data from the divisional pro forma operating income statements (see Appendix):

o Gross revenues are projected to be $12.5 million in the first three years of operation and $18 million from Year 4 onward.

o Cost of goods sold (COGS) is expected to be 56% of sales in the first three years and then decline to 50% of sales from Year 4 onward.

o The general and administrative costs are expected to be constant at $2.95 million per year over the 10-year planning horizon. Administrative costs include the allocation of senior management costs; the remainder of these costs relate directly to the new Motor Vessel division and are paid in cash when due.

• HK requires its customers to make a 15% deposit at the time of order and pay the balance at the time of delivery. The average lag between the time of order and delivery is two months. Sales occur uniformly throughout the year.

• HK has a policy of keeping a cash balance throughout the year equal to 2.5% of expected sales for the year, and an inventory balance throughout the year equal to 25% of expected COGS for the year. The cash balance is essentially funded by the required customer deposits and is invested in marketable securities at an average rate of 0.5%.

• HK’s suppliers currently offer terms of 1/10, net 60 on all purchases.

Capital structure

• HK’s capital structure consists of a single long-term debt issue with a face value of $20 million and 2 million common shares with a current market price of $15 per share.

• The long-term debt issue carries a coupon rate of 5% with interest paid semiannually. It has eight years remaining until maturity and a current market yield of 6%, also based on semi-annual compounding.

• The common shares have a beta of 1.15. HK paid a dividend of $0.95 per share in its most recently completed financial year. Analysts believe these dividends will grow at an average annual rate of 3% for the foreseeable future. The current risk-free interest rate is 2.5%, and the market price of risk is 6%.

• Recent discussions with HK’s investment banker have indicated that flotation costs would be 7% before tax on any new issue of common shares and 4% after tax on any new issue of long-term debt. Corporate Finance Project Details 3 / 3 General corporate information

• HK’s corporate tax rate is 32%.

• Senior management has determined that 12% is the appropriate discount rate to use in evaluating the proposal to expand its operations to motor vessels.

Question 4

HK’s senior management has decided to finance the new Motor Vessel division exclusively using new common equity. One proposal put forward was to make a rights offering. Explain what a rights offering entails and give one reason why this would be considered.

Question 5

Is the decision to raise approximately $20 million to finance the new division exclusively using new equity likely to affect HK’s WACC? Explain why or why not in terms of financial leverage, component costs, and capital structure. What is the likely impact? (Note: A recalculation of the WACC is not required for this question.)

Question 6

From the firm’s perspective, there are a number of advantages and disadvantages associated with using long-term debt and common equity as sources of financing. Identify one advantage and one disadvantage each for long-term debt and common equity.