MGT 404 - AllGoMotive Inc (AGM) was founded by Leslie Smith in 2012. A chemical engineer by training, Leslie

Question

MGT 404 - AllGoMotive Inc (AGM) was founded by Leslie Smith in 2012. A chemical engineer by training, Leslie

Question # 00138781 Posted By: jia_andy Updated on: 11/23/2015 12:09 PM Due on: 04/27/2016

Subject Business Topic General Business Tutorials:

Question

MGT 404

AllGoMotive Inc (AGM) was founded by Leslie Smith in 2012. A chemical engineer by
training, Leslie started the company after developing aluminum-air technology that could extend
the life of lithium-ion batteries. This technology (which she named, “the battery extension
system”) was used in “mission-critical” batteries and had recently been applied for use in electric
cars. In practical terms, the technology could extend a typical car battery’s life. On average, this
extension allowed it to operate for up to 1,000 miles between charges. Initial capital for the
company was provided by Leslie and three family friends, with Leslie being the majority
shareholder. Additional debt financing was provided by a regional bank.
AGM had just finished a great fiscal 2014, and things continued to look bright for its
projected fiscal 2015 (which began on November 1st, 2014). First, just before its 2014 year-end,
AGM signed 5-year agreements with two of the largest electric car manufacturers in the country.
Importantly, both manufacturers were quite profitable despite the fact that electric cars had yet to
gain a real foothold in the marketplace. While some of the pricing terms had yet to be ironed out
for the last two years of each contract, Leslie was optimistic about the contracts’ potential to
drive future growth in the company.
Second, Leslie had spent time over the last year improving on AGM’s existing product.
In particular, she had developed a battery extension system that would now allow car batteries to
last up to 2,000 miles between charges. She had already branded the new product as, the “Battery
Extender 2000” (code named BX2000). The patents for the new product were likely to be
completed somewhere near the end of fiscal 2015. Leslie was optimistic that the new technology
would not only open up more growth opportunities for AGM, but also make it more difficult for
new entrants to compete with her company.
Finally, Leslie had approached her bank about obtaining additional debt financing at the
beginning of fiscal 2015. The additional financing (which would be added to AGM’s existing
loan from the same bank) would help fund the company’s new growth initiatives and give the
company sufficient operating flexibility. To date, AGM’s bank loan had been structured so that
AGM would not have to pay down any of the loan until fiscal 2020 (although AGM would have
to pay applicable interest on the loan in every year). As part of the negotiations for the additional
financing, the bank wanted to restructure the terms of AGM’s loan. Specifically, on top of
providing additional debt financing, the bank agreed to charge AGM a lower interest rate in
fiscal 2015 than it had been charged in fiscal 2014. However, the bank also insisted that AGM
would now have to start re-paying back substantial portions of its debt by the end of fiscal 2016
instead of fiscal 2020. Moreover, AGM would be charged a higher interest rate on its loan (i.e.,
20%) starting at the beginning of fiscal 2016. Leslie thought she needed the extra financing to
help her firm grow, but wasn’t entirely sure about how the additional financing would affect
other elements of her business. In particular, while the new loan terms seemed to yield some
benefits for fiscal 2015, they also appeared to generate some drawbacks for fiscal periods beyond
2015.
You have been friends with Leslie for years. It is now November 2nd, 2014 and you just
found the following email in your inbox:

Exhibit 1: Assumptions and expectations for fiscal 20151
Fiscal year end for AGM is October 31st. Additional assumptions and expectations are listed
below.
1) According to the new terms negotiated with the bank, the bank will provide AGM with
an additional $3,680,000 of debt financing at the beginning of fiscal 2015. Interest
payments totaled $115,000 in fiscal 2014, and interest payments are expected to increase
to $460,000 in fiscal 2015.
2) During fiscal 2014, AGM paid out a total of $3,450,000 in cash relating to wages. In
addition, wage expenses were allocated as follows. 80% of wage expenses were allocated
to the manufacturing of the battery systems and the remaining amount was allocated to
executive salaries. The expectation is that AGM will end up paying $4,855,000 in cash
relating to wages during fiscal 2015 (and once again, in 2015 80% of the total wage
expenses will be allocated to manufacturing the units, and 20% will relate to executive
salaries).
3) AGM ended up making $1,725,000 in cash payments for inventory materials in fiscal
2014. In fiscal 2015, cash payments for inventory materials are expected to be 225% of
what they were in fiscal 2014.2 This increase is not related to an increase in input costs,
as AGM is expecting to get a unit discount on some of its inputs next year. This increase
arose because AGM felt it needed to stock up on product to keep up with expected
demand.
4) Cash collected from customers in fiscal 2015 is expected to increase by 20% from the
$6,612,500 collected in fiscal 2014.
5) AGM’s lawyer (Mark Eagleton) has been particularly impressed by AGM’s future
growth prospects. As a result, Leslie expects Mark to do all of AGM’s patent filing for
the BX2000 in 2015 in exchange for shares in the company. The value of the legal work
to file the patents in multiple countries was expected to reach $250,000, and the patents
were expected to be filed at the end of fiscal 2015. In addition, AGM is expecting to issue
$230,000 of additional shares in fiscal 2015 (for cash). No shares were issued in fiscal
2014.
6) On November 1st, 2014, AGM got rid of one of its original pieces of equipment: the
AlO2 Purifier Max. Leslie commented that, “We realized on November 1st that the
machinery was completely useless. The net carrying value on the balance sheet was
$200,000 and I ended up immediately selling it for scrap for $10,000.”
1

The impact of all assumptions has been incorporated in to the pro-forma financial statements for fiscal 2015.
By “cash payments for inventory materials are expected to be 225% of what they were in fiscal 2014”, we mean
that if cash payments for inventory materials were $1 in 2014, they are expected to be $2.25 in 2015.
2

7) Cash purchases of equipment were $230,000 in fiscal 2014 and are expected to be
$705,000 in fiscal 2015. All of the firm’s property, plant, and equipment is deemed to be
general purpose (i.e., none of the equipment is explicitly used for manufacturing).
8) Rent payments for office space are expected to increase to $450,000 in fiscal 2015. AGM
paid out $300,000 in rent payments during fiscal 2014.
9) During fiscal 2014, AGM paid out $160,000 in insurance premiums. After switching
insurance companies and negotiating higher deductibles, insurance premiums paid in
fiscal 2015 are expected to be $150,000.
10) Dividends declared and paid were $287,500 in fiscal 2014 and are expected to be
$345,000 in fiscal 2015.
11) Taxes are always paid in full during the following fiscal year. AGM’s effective tax rate is
24%.
12) The firm uses the periodic inventory method to account for COGS.
13) Assume that all sales are initially made on account.
REQUIRED:
1.) Create the income statements for the fiscal 2015 pro-forma [NOTE: please use the same
format for the income statement as in Exhibit 2]. (13 points)
2.) Create the statement of cash flows for the fiscal 2015 pro-forma using the indirect
method. (22 points)
3.) Are the types of cash flows observed in your answer to question 2 consistent with the
current stage in the company business cycle? Explain. (2 marks)
4.) Leslie is concerned about the bank loan restructuring in 2015. Citing your analysis above,
do you think it’s necessary for AGM to incur additional debt in 2015? Explain. (2 marks)
5.) Calculate the inventory turnover ratio, accounts receivable turnover ratio, fixed asset
turnover ratio, total asset turnover ratio, debt-to-equity ratio, interest coverage ratio,
return on equity, and return on assets for both 2014 and 2015 (pro-forma). Additionally,
provide a formula to illustrate how you calculated each ratio. (8 marks)
6.) Following your discussion of financial statements with Leslie, she comments, “That’s
funny. Even though we were expecting higher profits in 2015, return on assets is lower in
2015 than in 2014. What’s even stranger is that return on equity is higher in 2015 than in
2014. I have no idea what’s going on!!” Using tools you’ve learned in class, explain these
results. (6 marks)
7.) Discuss how the inventory turnover ratio, accounts receivable turnover ratio, interest
coverage, current ratio and quick ratio have changed between 2014 and 2015 (pro-forma).
In each case, please indicate whether AGM should be concerned about the trend they
observe. Use case points to back up your answers. (5 marks)
8.) “Hmmm… looking at my statement of cash flows it looks like my cash flow from
operations might have been higher if I sold the machinery for… less? Is that correct?
Cash flow is important to me, maybe I should have sold the equipment for one dollar.
Does that make sense?” All else equal, if Leslie had sold the machinery for $1, what
would her cash flow from operations have been? Illustrate how you got to your answer.
All else equal, if Leslie had sold the machinery for $1, what would her total change in
cash flow have been? Illustrate how you got to your answer. (4 marks)
9.) “Before my accountant quit, she mentioned that I could have actually had a projected
increase in my ROA from fiscal 2014 to fiscal 2015, had I (1) not sold my equipment and

(2) chosen to account for the equipment on my balance sheet in a very aggressive
manner. I’m not sure how that’s possible, given that not selling my equipment would
have just added more assets to my balance sheet.” Explain the accountant’s reasoning
using tools learned in this class. (4 marks)

Other notes:
• Please submit your assignment in PDF form. Please ensure that you put your name on the
assignment.
• This assignment is to be completed individually and with no discussion with your
classmates
• There are 66 total marks available for this assignment.
• This assignment is worth 15% of your final mark.
• When calculating ratios use the ratio definitions discussed in class. However, I appreciate
that there may be different ways to define ratios based on information presented in the
case. Thus, remember to provide a formula to illustrate how you calculated your ratios.
• When discussing or explaining your reasoning for any of your responses, a good rule of
thumb is to use no more than 2 sentences per mark available (i.e., please do not be overly
verbose when discussing your answers).
• There are often different ways to interpret the information presented in any case. If there
are any concerns on how to answer a given question due to a perceived ambiguity in this
case, please make a note of the assumptions you used to generate your answer. If your
reasoning is sound, you will receive full credit.

Exhibit 1: AGM Balance Sheet for 2013, 2014, and pro-forma 2015
For fiscal year ending October 31st
Assets
Current Assets
Cash
Accounts receivable
Inventory
Prepaid rent
Prepaid insurance
Total Current Assets

2015 pro-forma

2014

2013

1,449,890
1,200,000
3,300,000
138,000
92,000
6,179,890

540,500
920,000
471,500
126,500
115,000
2,173,500

230,000
1,035,000
437,000
115,000
138,000
1,955,000

Non-Current Assets
Equipment (net)
Patent
Total Non-Current Assets
Total Assets

1,335,875
250,000
1,585,875
7,765,765

977,500
977,500
3,151,000

805,000
805,000
2,760,000

Liabilities and Shareholders’ Equity
Liabilities
Current Liabilities
Accounts payable (for inventory)
Interest payable
Salaries payable
Taxes payable
Short term portion of loan payable
Total Current Liabilities

747,500
115,000
287,500
157,830
1,340,000
2,647,830

598,000
115,000
195,500
99,360
1,007,860

345,000
92,000
172,500
34,500
644,000

Long-term Liabilities
Loan payable
Total Liabilities

3,490,000
6,137,830

1,150,000
2,157,860

1,150,000
1,794,000

Shareholders’ Equity
Capital stock
Retained earnings
Total Shareholders' Equity

1,055,000
572,935
1,627,935

575,000
418,140
993,140

575,000
391,000
966,000

Total Liabilities and Shareholders’ Equity

7,765,765

3,151,000

2,760,000

Exhibit 2: AGM Income Statement for 2014
AGM
Income Statement
For fiscal year ending October 31st
Sales
COGS
Gross Profit
Operating Expenses:
Rent
Insurance
Depreciation Expense
Interest Expense
Salaries Expense
Operating Expenses:
Gains or Losses
Income before taxes
Income taxes
Net Income

2014
6,497,500.00
4,721,900.00
1,775,600.00
288,500.00
183,000.00
57,500.00
138,000.00
694,600.00
1,361,600.00
414,000.00
99,360.00
314,640.00

Attachments

2015_Case_Assignment_2.pdf (519.61 KB)