Spiing 2u14 uW0 NBAB 6211 BC Case: Colonial Back Ciackeis

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Colonial Back Ciackeis is a small physical theiapy piactice in the Washington BC
aiea. Colonial has been in business foi seveial yeais focusing on pioviuing PT
seivices anu piouucts. ueoige, a uW0 NBA giau, founueu anu continues to iun the
business.

Foi vaiious ieasons incluuing new entiants in the PT space anu maigin
compiession fiom ieuuceu payments fiom insuiance companies, Colonial become
unpiofitable anu staiteu to have cash flow pioblems. ueoige, with two kius about to
enioll as fieshmen at uW0, sought a buyei foi Colonial. Because of ueoige's
supeiioi connections thiough uW, he founu a buyei in S months; Buff 0ut Youi Pain.
Buff, a laige iegional pioviuei of physical theiapy anu pain management, askeu to
see Colonial's financial statements.

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Beie aie the cuiient book anu maiket values of Colonial's assets anu liabilities,
which Buff is inteiesteu in acquiiing. Against these assets aie claims of supplieis
anu bank loan useu to finance a poition of the inventoiy. Buff hiieu a valuation
consultant foi Colonial's tangible assets anu liabilities. Below aie the consultant's
conclusions.

Assets & Liabilities Current estimated Market Value
Inventory 1,000,000
Equipment 850,000
Buildings 2,100,000
Land 400,000
Total assets 4,350,000
Accounts payable 375,000
Notes payable 1,200,000
Net assets 2,775,000

Buff's business analysts calculateu a value of $S,u2S,uuu foi Colonial's net assets
incluuing $2Su,uuu of goouwill anu accoiuingly, on }une Su
th
, 2u1S Buff maue an
offei which was accepteu.




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Buff's plan is to incoipoiate Colonial's cuiient piactice into Buff's laigei facility next
uooi. Buff estimates that aftei the integiation is completeu, Buff will have total
assets of $16,uuu,uuu. Buff expects gioss piofit maigins of Su% anu inventoiy
tuinovei iatios of 6 anu to be able to caiiy 1u times the inventoiy. Thus Buff expects
futuie annual sales of $12u,uuu,uuu ($1,uuu,uuu X 6 X 2 X 1u) anu with a net piofit
maigin of 1u% shoulu iesult in net income of $12,uuu,uuu.

To finance the Colonial acquisition, Buff issueu 1,uuu,uuu shaies of $u.u1 pai which
was puichaseu foi $6,uuu,uuu. 0n }uly 1
st
, 2u1S, Buff boiioweu $7,8uu,uuu on a 1u
yeai 6% loan with inteiest payable eveiy 6 months anu the face value uue at the enu
of the 1u yeais. Buff paiu cash of $S,u2S,uuu foi all of Colonial's assets anu uebts
anu began the integiation piocess.

As pait of the puichase, Buff was able to use its size to ienegotiate the iate of the 6%
S yeai $1,2uu,uuu loan uown to 4% anu extenu its teim 4 yeais with inteiest anu
piincipal payable in 4 yeai-enu equal payments.

Buff's iesulting balance sheet as of Septembei 1
st
, at the enu of loan negotiations,
integiation, anu new inventoiy policy is shown below. Assume that both loans
began as of Septembei 1
st
so no inteiest neeus to be calculateu uuiing the staitup
peiiou fiom }une Su
th
to Sept 1
st
.

Balance sheet items Book Value after Combining Operations
Cash 10,000,000
Accounts receivable 0
Inventory 0
Equipment 2,550,000
Buildings 3,000,000
Land 450,000
Colonial Good Will 250,000
Total assets 16,250,000
Accounts payable 375,000
Notes payable (details below) 9,000,000
$0.01 par value Common stock (1M shares) 10,000
Spiing 2u14 uW0 NBAB 6211 BC Case: Colonial Back Ciackeis
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Balance sheet items Book Value after Combining Operations
APIC 6,865,000
Total liabilities+equity 16,250,000

Loans Amount borrowed
Notes payable 1 (4 year 4% equal annual payments) 1,200,000
Notes payable 2 (10 year 6% semi-annual payment of
interest, principal repayment at end of term)
7,800,000

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0n Septembei 1
st
, 2u1S the Buff openeu the integiateu Colonial facility. Beie aie
the summaiy tiansactions foi the iemaining 4 months of the yeai:

1. The firm paid off all existing accounts payable to the suppliers
2. It paid $130,000 on two-day vacation for its most important suppliers.
3. To announce the newly integrated facility, Buff spent $100,000 contacting Colonials
customers and letting them know of the additional services Buff offers.
4. Gross purchases of inventory totaled $11,230,000. Purchase returns were $25,000. The
firm was conscientious about taking cash payment discounts and took $120,845 in cash
discounts. At year-end the firm had remaining accounts payable of $1,480,000.
Transportation-in costs, all paid in cash, were $130,000 [hint: you can calculate cash paid
to suppliers for inventory purchases from this information.]
5. All sales are on credit. Sold inventory for $18,500,000 at a gross profit margin of 50%.
The firm uses average costing for inventory and keeps perpetual records but instead of
keeping track of each items cost, the firm records cost of goods sold of 50% of revenues
for each sale. Thus, the cost of goods recorded for each sale during the year is an
estimated amount, not the actual cost of the individual item sold. This saves the firm the
cost of keeping detailed records but also permits it to create periodic interim reports.
At the end of the year, a physical inventory count is taken and the inventory valued. The
inventory account is then written down or up (with the cost of goods sold being the other
journal entry line) so that the inventory accounts year-end balance matches the count and
valuation of the actual physical inventory.
6. Sales returns for the period were $250,000 and total cash discounts given were $300,060.
7. The firm paid $165,000 for electricity, telephone, and other administrative and office
expenses.
8. Paid $1,839,750 for salaries and wages of general operations and administration together
with all the payroll taxes (FICA) and various other payroll related costs.
9. Advertising and other selling costs of $600,000 were incurred and paid during the period.
Salaries, wages, and other payroll costs for the sales function was $1,010,250.
10. Paid transportation-out costs for the period were $750,000.
11. The uncollected accounts receivable at the end of the year was $2,325,000. [hint: you
can now calculate the cash collected from accounts receivable with this information.]
12. The firm purchased insurance and prepaid some other expenses to the amount of
$230,000.
13. Total of property taxes assessed by all jurisdictions where facilities are located is
$32,000 of which $2,000 remained to be paid at year-end.
14. The firm collected a $15,000 surety deposit for a special order for submersible electrical
motors.
15. The corporate income tax rate is 35%.
Information collected for making adjusting entries

After looking through the books and various financial records the controller has collected the
following information for making adjusting entries.

1. The percentage of ending receivables estimated to be uncollectible is 1%.
2. The valuation of the physical inventory found that the ending inventory balance needed to be
$1,450,500.
3. Payroll expenses incurred but not paid as of Dec 31st. was $50,000. This amount is not
included in the $1,839,750 amount mentioned in paragraph 8 in the transactions listing.
4. Fulfilled $10,000 of the special order for submersible motors described in paragraph 14 in the
transactions listing.
5. The firm uses straight line depreciation. The cost of the original Colonial equipment
($850,000) is estimated as having an useful life of 5 years and salvage value of zero. Newer
equipment purchased by Buff ($2,550,000 - 850,000) is being depreciated over various
lifetimes given below.
Type Cost Estimated useful life Salvage Value
Information technology $1,580,000 3 years 0
Transportation equipment 120,000 10 years 10,000


6. The cost of the original Coloinal Buildings ($2,100,000) is to be depreciated over 25 years
with a salvage value of $100,000. The various improvements made by Buff ($900,000) are
being depreciated over 15 years with a salvage value of zero.

7. At the end of the year, the firm had used $63,525 of the $230,000 prepaid for insurance and
other expenses.
Spiing 2u14 uW0 NBAB 6211 BC Case: Colonial Back Ciackeis
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Required

(a) Present the year-end financial statements - the balance sheet, the income statement, the
statement of changes in equity and the cash flow statement. On the income statement be sure
to separate cost of goods sold, general and administrative expenses, selling expenses,
financial revenues or expenses, and incidental gains and losses (from selling of equipment for
example). In other words, your income statement should look like this:
Revenue $ 100
less: cost of goods sold 40
gross profit 60
General and Admin exp -10
Selling expenses -20
income from operations 30
Financial revenues & expenses -5
Incidental gains and losses 3 << incidental gain
Income before taxes 28
Provision for income tax 9.8
Net income 18.2

Round off all numbers to the nearest dollar - so no decimal points in your financial statements.

(b) If you are the bank loan officer in charge of Buffs loans what characteristics and measures
would you use to evaluate Buff? Present a short (3-4 paragraphs) discussion of your
conclusions. In your discussion, suggest what might be the maximum amount of secured
long-term (5 years or more) loan you would recommend that the bank lend?

(c) If you are Buffs business analyst what characteristics of the combined would you measure
and what conclusions would you draw about the effectiveness of the acquisition?

(d) If you are Buffs CEO - write a short report (max 1 page) as to what would you present to
your shareholders regarding whether the acquisition is on track to achieve Buffs business
plan. In particular, discuss Buffs cash flows and whether operating cash flow can be used be
for future expansion.