Upstate Canning Llc Case Study

Statement of Case Situation

        Upstate Canning LLC is a small privately owned fruits and Vegetable canning company. Mr. Fordham currently owns upstate, however his health is in question and he wishes to sell the company. From 1952-55, Mr. Fordham had hired a manager to run the business, but operations suffered and Mr. Fordham was forced to take over in order to bring the business back to adequate levels. Upstate’s property plants and equipment appear to be in great condition with no need for repairs coming in the next few years. Fordham historically only operates the plan during the months of the harvest season (July to October). Due to the frequent changes in prices seen in the fruits and vegetable industry, the variable costs for Upstate can change constantly.

Mr. Shields is interested in becoming the manager and majority stockholder of a company with growth potential. Mr. Shields has put together $35,000 as his investment fund, while also looking for other investors to help him finance his project. Mr. Fordham gave a proposal to Mr. Shields, after learning of his interest in the company. Under the proposal, Mr. Shield’s new company would acquire Upstate’s property, plant and equipment, as well as the right to use the Upstate brand name, and lastly $50,000 in finished goods inventory. The new company would have $400,000 in capitalization with $100,000 in common stock purchased by Mr. Shields and the investor and $300,000 in income bonds with interest payable of 3% per annum. Shields and the investor will split financial control of the new company while governing control of the company will be split between the income bondholders and the common shareholders until the income bonds have been retired. The company has the option of purchasing any amount of income bonds in excess of the minimum requirements according to a schedule of discounted prices. Mr. Shields desires to have 51% ownership of this new company within 5 years. The case concludes by offering three courses of actions: accept the proposal, deny the proposal, or propose a compromise. In order to answer this question a model has been devised.

Explanation and Presentation of Pro Formas

Monthly Balance Sheet

1. Assets

1. Cash: Cash starts at $100,000 in June due to the $35,000 investment by Mr. Shields and the $65,000 investment by the other unknown investor. In months coming after June, an “if statement” is used to maintain a minimum cash balance of $12,500.
2. Accounts Receivable- Accounts Receivable is equal to each months sales.
3. Inventory- Upstate starts with an initial balance of inventories of $50,000. For the other months, the following formula was used: Beginning Inventory + Cost of Goods Manufactured – Cost of Good Sold = Ending Inventory. The end of the month balance was then transferred over as the next month’s beginning inventory balance. Cost of Goods Manufactured is based off that one sixth of the production occurs in both July and October, while one third of the production is done in both August and September.

1. Total Current Assets- Total Current assets is calculated by adding Cash, A/R and Inventory.
2. PP&E - PP&E starts at 200,000, coming from the $200,000 worth of PP&E transferred from Fordham to Shields.
3. Accumulated Depreciation- This account accumulates the depreciation over the course of the 12 months. Fordham mentions that PP&E depreciated $24,000 per year, which comes out to be 12% yearly and 1% monthly.
4. Net PP&E- Net PP&E is shown by adjusting the starting PP&E by accumulated depreciation each month.
5. Goodwill- Goodwill was determined by finding the difference between Total Assets and Total Liabilities. Goodwill was amortized over 20 years in this model (5% per year) and adjusted in the monthly balance sheet to show the monthly impact.
6. Total Assets- Total assets is found by adding Total Current Assets, Net PP&E and Net Goodwill.

1. Liabilities and Owner’s Equity

1. Accounts Payable- AP is equal to the percentage of production or Cost of Goods manufactured. COGM can be seen through the purchase of cans and ingredients that are bought on account. Cost of Goods Manufactured is based off that one sixth of the production occurs in each July and October, while one third of the production is done in each of August and September.
2. Bonds Interest Payable- The Bond interest payable is current long term debt plus long term debt multiplied by the 3% interest rate on a monthly basis. Interest on the bond was paid off in December and June.
3. Note Interest Payable- Note interest is calculated based on multiplying the note payable by the 6% interest rate on a monthly basis. Interest on Notes Payable is paid semiannually, on June 30 and December 31.
4. Interest Payable – Interest payable is calculated by adding up Bond Interest Payable and Note Interest Payable.
5. Notes Payable- Notes payable was found by using an “if statement” that calculates the amount of notes that need to be raised to fund any gap between Total Assets and Total Liabilities and Equity without Notes Payable. If the Total Assets minus (L+E w/o NP) were greater than 0, then N/P is Total Assets minus (L+E w/o N/P). Otherwise, Notes payable was zero.
6. Taxes Payable- Taxes payable are taken from the taxes for the current month on the income statement and accumulate throughout the year.
7. Current Long-Term Debt- Current long-term debt remains $50,000 throughout the year, until the $50,000 worth of income bonds are repurchased in June. In June, $15,000 comes out of long-term debt and goes into current long-term debt. This occurs because Shields must repurchase a minimum of $15,000 in each succeeding year.

1. Total Current Liabilities- The sum of A/P, Bond Interest Payable, Note Interest Payable, Taxes Payable, and current Long-term Debt.
2. Long Term Debt- Long-term debt is $250,000 throughout the year, until June. In June the $50,000 of Current LTD is paid off, and $15,000 of LTD goes into current LTD, as this is the minimum amount Shields must repurchase each year. LTD becomes $235,000 in June.  
3. Total Liabilities – Total Liabilities is equal to long term debt added to Total current liabilities.  
4. Common Stock- This account reflects the initial capital investment made by Mr. Shields’ and his investors into Upstate Canning.
5. Retained Earnings – This account is equal to the net income for the month plus the balance from the prior month.
6. Total Equity- The sum of common stock and retained earnings.
7. Total Liabilities and Equity- Current Liabilities + Long Term Debt + Total Equity

Monthly Income Statement

1. Net Sales – 50% of the yearly sales of $850,000 are evenly split through July, August and September. The case said 50% of sales would occur by the end of the earnings, which I took to mean up until October and not including it. 20% of the yearly sales are split between October, November and December and the remainder is split evenly from January through June.
2. Variable Costs – Variable costs are equal to 89.05% of the Cost of Goods Manufactured, which is the same percentage of Cost of Goods Manufacture that are considered variable costs in 1956.
3. Fixed Overhead – Fixed Overhead is equal to 10.95% of the Cost of Goods Manufactured, which is the same percentage of Cost of Goods Manufacture that are considered fixed overhead costs in 1956.
4. Cost of Goods Sold- Cost of goods sold is equal to variable cost plus fixed overhead.
5. Gross Profit- Gross Profit is the difference between Sales and Cost of Goods Sold.
6. Selling and Delivery- This figure is taken from the case, and each month’s amount is a proportion of sales (7.53%).
7. Admin and General- After subtracting Mr. Fordham’s salary from A&G, the balance was $36,000. This amount was spread over the 12 months evenly.
8. Shields’ Base Salary- Mr. Shield’s salary of $15,000 is evenly spread out over the each month.
9. Sales, General & Admin- The sum of S&D, G&A and Shields’ base salary.
10. Bond Interest- Bond interest is equal to 3% of the current long term debt plus 3% of the long term debt, which then must be adjusted to reveal the monthly cost.

1. Note Interest- Notes Interest is the interest expensed on the loans at a 6% interest rate.
2. Interest Expense- The sum of bond interest and note interest.
3. Gain on Repurchase – It is equal to 0 in the first 12 months since no income bonds are repurchased in excess of the minimum.
4. EBBT- EBBT is equal to Gross Profit minus SG&A and Interest Expense.
5. Bonus- The bonus is given to Mr. Shields. It is equal to 5% of EBBT.
6. EBT- EBT is equal to earnings before taxes, or EBBT – Bonus.
7. Tax- The tax figure was found by multiplying the profit before tax by the tax rate of 45.71%. This tax rate was found by dividing the tax expense on the year 1 annual income statement by profit before taxes on the year 1 annual income statement (40,000/87,500).
8. Amortization Expense – is equal to 5% of goodwill, adjusted to display monthly cost.
9. EATBA – This account is equal to EBT minus taxes.
10. Net Income- Net Income is equal to EATBA minus amortization.

Annual Balance Sheet

1. Assets

1. Cash- The same “if statement” used for the monthly balance sheet was used for the Annuals. The only difference is that the minimum cash balance is $100.

1. Accounts Receivable- AR grows at the same rate as sales.
2. Inventory- All of the COGM were always sold by the start of the next canning season, so inventory was a constant $50,000 every year.
3. Current Assets- Current Assets equals the sum of Cash, Inventory, and Accounts Receivable.
4. PP&E, net- Depreciated on a straight line of $24,000 per year.
5. Goodwill- Goodwill is amortized at 20%.
6. Total Assets- Current Assets + PP&E, net + Goodwill

1. Liabilities and Owner’s Equity

1. Taxes Payable - This account is determined from the income statement.
2. Current Long Term Debt – Current Long Term debt is equal to half of the net income for the current year, which is used to repurchase income bonds.
3. Long Term Debt - Long term debt is equal to last year’s long term debt minus the Long Term Debt Current portion, minus any bonds that have been bought back.
4. Common Stock -         Common Stock remains at $100,000 for each year because the model assumes that there is no stock issuance or repurchase.

1. Retained Earnings- Found by adding a year’s net income to the previous year’s retained earnings.
2. Total Equity- Sum of Retained Earnings + Common Stock
3. Total Liabilities and Equity- Sum of Current Liabilities + Long Term Debt + Total Equity
4. Total Liabilities and Equity without N/P- Found the same way as in monthly Pro Forma.

Annual Income Statement

1. Sales- Projected sales were given in Exhibit 1.
2. Cost of Goods Sold- COGS were calculated by adding up variable costs and fixed overhead which were maintained at the same ratio of as in 1958.
3. Selling and Delivery- Found using same method as monthly S&D values
4. Admin and General- Found using same method as G&A for monthly Pro Forma.
5. Shields’ Base Salary- Held constant at $15,000 per annum.
6. Sales, General & Admin- Sum of S&D, A&G and Shield’s Base Salary.
7. Bond Interest- Bond interest was calculated in the same manner as on the monthly income statement.
8. Note Interest – Note Interest grew each year by 5% less than the sales growth.
9. Gain on Repurchase – Gain on the buyback is equal to 0 until 1961, when it is equal to the difference between the amount of bonds repurchased early and the discounted price paid to repurchase the bonds.
10. EBBT- EBBT is equal to Gross Profit minus SG&A and interest expense plus the gain on bond buyback.
11. Taxes- Taxes are calculated using an “if statement”. If EBT is less than $25,000 the tax rate is 30%. However, any EBT over $25,000 will be taxed at the rate of 52%.

Conclusion and Analysis

        According to the model prepared, Mr. Shields should accept Mr. Fordham’s proposal. Given the assumptions presented in the case and assumptions made in the creation of the model, Mr. Shields will be able to accomplish all of his goals. Mr. Shields will acquire majority ownership and control of the company within five years, while still maintaining an efficient and profitable company. In fact, according to this model, Mr. Shields will have 51% ownership by the end of his fourth year with Upstate. Furthermore, the company should also be able to fully pay back the $300,000 bond from Mr. Fordham. Upstate also never finishes a year with any outstanding notes payable or debt besides that from the income bonds. These facts about earnings and debt are a testament to the profitability and sustainable profitability of the company. In addition, if the macro situation changed and there was a downturn in the economy, Mr. Shields would still be able to accomplish his goals by the fourth year and the company would remain profitable. If such a downturn did occur, the total net income of the company over the five years would fall from a projected $422,000 to a projected $233,000. Though the net income does take a significant hit, the company does maintain profitability, one of Mr. Shields’ main goals. Furthermore, according to my WAAC and DCF analysis Mr. Shields is acquiring a valuable company with growth potential at a significant discount. In a base economy over the next five years, the company is valued at $3.6 million. It is projected to be worth, $5.1 million in a positive macro environment, where significant growth could be expected over the next five years. On the other hand, according to my DCF analysis Upstate is projected to be worth $2.2 million if a recessionary period occurs over the next five years. In order to complete to obtain the WAAC and complete the DCF, a beta of 1.49 was used. This is the current beta of Dole Food Company Inc. Dole Food Compnay is the producer, marketer and distributor of fresh fruit, fresh vegetables and packaged foods. When calculating the WAAC, I was choosing between using Dole’s beta of 1.49 and Fresh Del Monte Produce Inc’s beta of .77. I chose Dole’s beta of 1.49 as it allowed for more conservative valuations of Upstate. Using Del Monte’s beta of .77, the implied value of Upstate was $5.2 million with base projections, which seemed to be too generous. All of these different scenario projections, using Dole’s beta of 1.49, display that Mr. Shields investment of $35,000 and his further investment to gain 51% ownership of Upstate bring him a significant return and control of a very valuable asset. This DCF analysis sheds even more light on the case, as it shows that Mr. Shields stands to benefit from more than the simply accomplishing his goals. Thus giving Mr. Shields even more reason to accept Mr. Fordham’s proposal.