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Module 3 Assignment 4 Practice Case Examination Additional Information

(Time Allowed: 4 hours) Notes: i) ii) iii) iv) Candidates must not identify themselves in answering the question. All answers must be written on official answer sheets or in official electronic files. Work done on the question paper or on the Backgrounder will NOT be marked. Ensure you have a copy of the standard supplement consisting of formulae and tables that may be useful for answering the question. Only the following models of calculators are authorized for use on the Case Examination: 1. Texas Instruments 2. Hewlett Packard 3. Sharp TI BA II Plus (including the professional model) HP 10bII+ (or HP 10bll) EL-738C (or EL-738)

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Additional Information

Practice Case Examination M3A4

Celebrations and Memories Ltd. (CML) Additional Information


Store Locations and Performance To take advantage of the growth in Western Canada, CML had opened three stores in British Columbia in 2008. These stores have proven to be profitable (see Appendix A). Sales revenue has grown by 8% each year, and retail operating profit per store in 2011 is 19% above the average of all CML stores. The Ontario and Quebec stores have seen a slow decline in sales and operating profits over the past few years and the two Nova Scotia stores (established in 2005) have experienced a more pronounced decline. Currently, one area sales manager is responsible for stores in British Columbia and Nova Scotia, one for stores in Central and Western Ontario, and the third one for stores in Eastern Ontario and Quebec. In early 2011, CML opened two stores in new secondary malls built in growing Southern Ontario cities in which CML had other established stores. These new stores have generated reasonable operating profit margins in their first year of operations. Durands Retirement In early 2011, Mark Glenholmes had become seriously ill and the family decided to admit him into a private clinic in the United States for treatment. In March 2011, the board of directors approved Marie Durands request that CML begin repaying her shareholder loans at a rate of $30,000 per month. In December 2011, Durand retired as CEO and indicated that she wished to sell the family ownership interest in CML by 2014. With Durands retirement as CEO, Gordon Hopps was promoted to the CEO position and Chris Mantha was appointed Vice President of Finance and Administration. As well, Robyn Berg, CMA, was hired as Controller to help Mantha carry out his administrative and finance responsibilities, and to supervise the accounting staff. In January 2012, the board of directors expressed concern over the stagnating sales and increasing operating expenses. In the past, it had adopted expansion and product diversification strategies with reasonable success, and saw no reason to change these strategies. The board directed management to investigate various options for increasing revenues and gross profit margins, and decreasing expenses. Given Durands desire to increase the value of the shares before trying to sell them, the board set a target of increasing the companys after-tax earnings per share to at least $6.25 by 2014 and, at the same time, continue to repay Durands shareholder loans at a rate of $30,000 per month.

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CMA Canada

Practice Case Examination M3A4

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Product Line Considerations In late 2011, Mantha investigated various product diversification options and determined that the two new product lines with the best potential were collectible plates and DVDs. Collectible Plates CMLs giftware line currently includes some decorated plates, but these are not the registered, limited edition collectible plates that have an established customer market. This type of product line is usually sold in stores in the major malls and through mail order. There would be little or no direct competition from other stores in the secondary malls. As such, it is expected that adding this product line would attract new customers to the stores. This option would require CML to become a licensed dealer for the plate manufacturers, whereby the stores would take orders from plate collectors and the manufacturer would make weekly deliveries to the stores. Customers would be required to place a deposit of 50% of the price of the plate upon placing the order and the balance would be payable when the plate is picked up, usually one to two weeks after placing the order. It is expected that the current store employees would be able to handle the added paperwork required to keep track of open orders and deposits, and to call customers when orders come in. However, during the busy times just prior to holidays, dealing with plate orders could cause delays in handling customer sales for other products, which could cause customer frustration and some lost sales. Adding this product line would require the addition of a special display case that keeps sample plates locked behind a glass enclosure to prevent theft and damage. This would require that approximately 20 sq. ft. of selling space for other products would be reduced. The initial investment per store to add this line would be $700 for the sample plates plus $800 for the display case. Mantha estimated that this line could generate annual revenues of $7,000 to $8,000 per store and that the gross profit margin would be 30% of sales. DVDs CML stores could accommodate adding DVDs as a product line without affecting the selling space of other products by using mobile racks to display them at the edge of the open mall side of the stores during store hours. This product line would appeal more to youths and young adults than to the more mature customers who currently shop at CML stores. DVDs cannot be returned to the supplier. To discourage misuse of the DVDs by customers (e.g. purchase, view, and then return), Tamar Shah suggests that a policy of all DVD sales are final be adopted.

CMA Canada

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Practice Case Examination M3A4

Mantha determined that the average initial investment per store would be approximately $1,000 for inventory and $500 for a mobile rack, annual revenues of $6,000 to $7,000 per store from DVD sales could be generated, and the gross profit margin would be 50% of sales. However, there is a high risk of theft for this type of product, which could result in having to increase security at the stores. Possible Store Expansion Claude Denis has indicated that opportunities for expansion are limited to opening stores in new secondary malls being built in growing urban sectors or finding available leases in established malls that do not already have stores offering similar products as CML. He feels that over the next two years at most two suitable locations to open a store could be found in B.C., three in Alberta, and two in Ontario. Initial costs to open a store in B.C. or Ontario are as follows: Low $ 18,000 11,000 53,000 4,000 19,000 $105,000 Average $ 20,000 12,000 55,000 5,000 23,000 $115,000 High $ 22,000 13,000 57,000 6,000 27,000 $125,000

Leasehold improvements Furniture and fixtures Inventory First and last months rent Other (finding location, hiring and training, store opening promotional campaign, etc.) Total

Costs to open a store in Alberta would average approximately $137,000. For stores in Western Canada, annual travel and courier costs (absorbed by head office) are $8,000 per store greater than for those in Central Canada. Shah estimates that, in comparison to a B.C. store, retail revenue for a store in Alberta would be 10% higher, gross profit margin percentage of retail sales would be the same, postal outlet and lottery booth revenues would be the same, and total operating costs for stores, postal outlets and lottery booths would be 15% higher. Mantha feels that, for any new store location, CML should attempt to negotiate contracts for operating a postal outlet and a lottery booth. Denis estimates that the probability of successfully negotiating a contract would be 25% for a postal outlet and 40% for a lottery booth. Warehousing Mantha noted that gross profit margins for tobacco products have decreased due to increasing delivery charges (see Appendix B). The purchasing agent has suggested that CML could realize substantial savings by purchasing giftware and tobacco products in bulk and handling the distribution to stores internally. To implement this option, a warehouse could be constructed on CMLs existing head office property and two

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CMA Canada

Practice Case Examination M3A4

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vehicles and drivers could be acquired to make deliveries to the stores in Ontario and Quebec. Purchases and deliveries for the B.C. and Nova Scotia stores would continue to be handled in the current manner. Expected costs savings for CML are as follows: 1. Purchasing giftware in bulk with delivery to a central location would reduce the purchase cost by 15%. 2. The cost of cigarettes would decrease by $3 per carton. In 2011, CML sold an average of 1,850 cartons of cigarettes per store. 3. The cost of other tobacco products would decrease by a total of about $100,000 per year for CML, assuming the same sales volumes as in 2011. The warehouse could be fully operational by the end of 2012. The cost to build the warehouse would be $1,000,000 and its value is not expected to decline over the next 40 years, assuming it is properly maintained. CMLs bank is prepared to provide a mortgage of 75% of the cost of the building at an annual interest rate of 6%. The loan would be interest only (i.e. no principal payments required during this period) for the first five years. The loan proceeds are expected to be advanced in 10% increments until construction is complete, which should take about 10 months. The equipment and vehicles would have an expected useful life of seven years and could be purchased at a cost of $300,000 or leased from Business Financing Inc. (BFI). The lease terms would be annual payments of $77,000 per year for five years (providing BFI with a 9% return on investment), payable at the beginning of each year, with an option to purchase the equipment and vehicles for $3,000 at the end of five years. The equipment and vehicles would have a maximum CCA rate of 30%. They would have an estimated residual value of $100,000 after five years and $20,000 after seven years. Mantha determined that the annual costs of operating and maintaining the warehouse, vehicles and equipment, and delivering the goods to the Ontario and Quebec stores would be $340,000. Financial Situation The repayment of Durands shareholder loans has caused CMLs financial situation to deteriorate, particularly in terms of cash flow. In 2011, CML was forced to use some of its $500,000 bank line of credit (at an annual interest rate of 8%) for the first time in many years. In January 2012, Mantha asked the bank to raise CMLs line of credit to $1 million, offering all CMLs inventory as collateral. The loan officer at the bank has requested that audited financial statements for the year ended December 31, 2011, be provided. The bank would also like to know how CML plans to finance its operations in the longer term.

CMA Canada

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Practice Case Examination M3A4

Management Report Hopps scheduled a senior management meeting to take place on February 1, 2012, to assess CMLs options for meeting the boards objectives. He requested that the specific opportunities already identified be analyzed and the findings presented at the meeting. As well, with the retirement of Durand, Hopps is open to suggestions for changing any aspects of the companys operations to improve profitability and employee motivation for delivering high quality service to customers. He believes that the relationships employees develop with regular customers are critical to the success of CML stores. Hopps and Mantha agreed that, because Berg is new to the organization, he would not have any biases and therefore should be given the responsibility of reviewing the companys current operations, analyzing alternatives, and making recommendations for meeting the boards objectives and addressing any other concerns. In addition, Mantha would like Berg to do the following in connection with the banks request for audited financial statements and a financial plan: 1. Review the accounting policies and recommend any changes required to ensure that the financial statements comply with International Financial Reporting Standards. 2. Review the current processes and recommend any changes required to improve or facilitate an external audit. 3. Identify how any recommended strategies would affect the future financial statements and cash flows. Additional Information 1. CML expects to earn a minimum after-tax return of 9% on capital investments. 2. The company uses a periodic inventory system. Because January is typically a slow sales month, the stores are closed on the second Sunday in January so that inventory can be counted. The prices on the most recent invoices from the individual suppliers are used to value the counted inventory and the total value of this inventory is recorded as the December 31 year-end inventory balance. 3. The area sales managers have estimated that as much as 2% of sales is lost through theft and breakage. However, this cannot be verified using the current information systems. Theft is especially prevalent for items that are close to the store opening or in corners furthest away from the customer service desk. 4. Up to 10% of the giftware inventory becomes obsolete each year and must be sold at deep discounts, usually at a loss. Obsolete goods are kept on display at the stores until they are sold. 5. At the beginning of the lease term for an individual store, CML is required to pay the first and last months rent. These payments are expensed when they are paid.

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Practice Case Examination M3A4

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6. Berg analyzed the cost of giftware sold in 2011 and determined the following: Province Ontario Quebec British Columbia Nova Scotia Average Cost of Goods Sold per Store $52,230 $52,760 $59,090 $53,550

7. At three stores in Eastern Ontario, the area sales manager approved the hiring of children of the store managers as extra part-time sales clerks during busy times. In all three cases, the managers children were paid in cash from the cash register and these cash payments were reported to head office as repairs and maintenance expenses. In 2011, these payments amounted to approximately $3,000 in total. 8. The company has implemented a new layaway program. Customers must pay a 20% non-refundable deposit for the layaway of an item, up to 2 months. Some of the stores have implemented this policy and are recording the entire sale at the time the deposit is taken. A receivable from the customer is recorded for the remaining 80%. If the customer changes his or her mind later, the sale is reversed, except for the deposit, which is retained by the company and shown as other income. 9. Periodically, the performance of all full-time staff is reviewed. Performance appraisals are prepared and delivered by the employees immediate supervisor, and the employee is required to sign a copy of the appraisal. Although sales targets are set for each store, CML has no incentive plan in place. 10. One of the assistant purchasing agents appeared to be recommending a disproportionate number of purchases from one particular giftware supplier. An investigation revealed that one of the suppliers commercial sales representatives is married to the employees sister and that the two couples frequently travel together on vacation, with the expenses paid by the sales representative. REQUIRED: As Robyn Berg, CMA, prepare a report for Gordon Hopps and Chris Mantha advising them on the business and functional strategies to follow in order to meet the objectives of the board of directors. In addition, the report should address the specific requests made by Mantha as well as any other organizational issues and concerns requiring the attention of management. Include details of your analyses, supported recommendations, and an action plan to implement your recommendations. In undertaking this task, you will need to take into consideration your background knowledge of the company and industry as well as the additional information provided above.

CMA Canada

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Practice Case Examination M3A4

Appendix A Celebrations and Memories Ltd. Operating Profit Analysis For the Year Ended December 31, 2011 (dollar amounts in 000s)
Ontario Stores Number of stores Number with postal outlet Number of lottery booths Retail: Revenue Cost of goods sold Gross profit Expenses: Administration and security Direct wages and benefits Rent Other occupancy costs Repairs and maintenance Selling Operating profit retail Postal Outlets: Revenue* Direct wages and benefits Store overhead Operating profit postal outlets Lottery Booths: Revenue* Direct wages and benefits Rent Operating profit lottery booths Total Operating Profit 39 8 12 Quebec Stores 10 2 4 B.C. Stores 3 1 3 N.S. Stores 2 1 1 Total 54 12 20

$19,785 13,293 6,492 276 2,344 1,182 967 156 152 5,077 1,415

$5,213 3,587 1,626 71 599 297 243 41 40 1,291 335

$1,664 1,132 532 21 182 96 79 13 13 404 128

$964 659 305 14 106 61 50 10 7 248 57

$27,626 18,671 8,955 382 3,231 1,636 1,339 220 212 7,020 1,935

402 (296) (49) 57

100 (74) (12) 14

50 (37) (5) 8

50 (34) (6) 10

602 (441) (72) 89

436 (330) (14) 92 $ 1,564

146 (110) (5) 31 $ 380

109 (82) (4) 23 $ 159

36 (27) (1) 8 $ 75

727 (549) (24) 154 $ 2,178

* Total sales for Postal Outlets and Lottery Booths have remained flat over the past three years.

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Appendix B Celebrations and Memories Ltd. Product Line Analysis For the Years Ended December 31
2011 Revenue per Store (000s) Greeting cards: - Occasion - Holiday - Dollar Total greeting cards Tobacco products: - Cigarettes, cigars, other - Accessories Total tobacco products Giftware Confectionery Magazines and newspapers Gift wrap Stationery Total $103.8 41.6 10.8 156.2 GP* per Store (000s) $ 43.7 20.9 4.3 68.9 Revenue per Store (000s) $104.2 41.8 10.9 156.9 2010 GP* per Store (000s) $ 44.0 21.0 4.3 69.3 Selling Space in Sq. Ft. Average Store** 400 150 150 700 2011 Gross Profit per Sq. Ft. $ 109 139 29 98

GP* Margin 42.1% 50.2% 39.8% 44.1%

GP* Margin 42.2% 50.2% 39.4% 44.2%

136.5 20.6 157.1 99.4 31.2 26.3 25.8 15.6 $511.6

9.5 7.8 17.3 46.6 9.5 5.1 12.5 5.9 $165.8

7.0% 37.9% 11.0% 46.9% 30.4% 19.4% 48.4% 37.8% 32.4%

137.2 20.7 157.9 99.6 31.1 26.2 25.6 15.1 $512.4

10.3 8.1 18.4 43.9 9.3 4.9 12.1 5.4 $163.3

7.5% 39.1% 11.7% 44.1% 29.9% 18.7% 47.3% 35.8% 31.9%

10 5 15 600 5 120 60 20 1,520

950 1,560 1,153 78 1,900 43 208 295 $ 109

* GP = Gross Profit ** Each store is 1,500 to 2,100 sq. ft., of which 1,300 to 1,700 sq. ft. is selling space and 200 to 400 sq. ft. is non-selling space (office, storage, restroom, etc.). Stores with a postal outlet use 150 sq. ft. of space for the postal service counter and the postal outlet storage room.

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