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Chartered Professional Accountants of Canada, CPA Canada, CPA are trademarks and/or certification marks of the Chartered Professional Accountants of Canada. © 2020, Chartered Professional Accountants of Canada. All Rights Reserved. Les désignations « Comptables professionnels agréés du Canada », « CPA Canada » et « CPA » sont des marques de commerce ou de certification de Comptables professionnels agréés du Canada. © 2020 Comptables professionnels agréés du Canada. Tous droits réservés. 2019-10-04 Finance — Integrated Problem 6 Scenario (90 minutes) You, CPA, work as an associate with Campbell and Associates LLP, a financial and business advisory firm. The CFO of Milltown Flakeboard Ltd. (MFL) has approached your firm to do some additional work. MFL is looking to sell one of its subsidiaries, Milltown British Columbia Inc. (MBC), which operates in British Columbia, and has engaged Campbell and Associates to prepare a valuation. It is February 21, 2020, and you have been asked by your boss, Heather Larimer, to assist on this engagement. MFL has been approached by some potential purchasers and thus would like to have a valuation performed to determine a reasonable selling price for the MBC business. The CFO has provided the financial statements (Appendix I) and additional information to assist with these valuations (Appendix II). Heather has asked you to prepare a draft of this report to the CFO of MFL. Task #1 Calculate maintainable earnings before interest, tax, depreciation, and amortization (EBITDA) for MBC using an average of the last four years weighted as follows: 40% for 2019, 30% for 2018, 20% for 2017, and 10% for 2016. Your response should be no longer than one half of a page, excluding any Excel files. Task #2 Prepare a valuation of the equity of MBC as at December 31, 2019, using a capitalized cash flow approach. Your response should be no longer than one half of a page, excluding any Excel files. Finance — Integrated Problem 6 Problem 2 / 5 Task #3 Prepare a valuation of the equity of MBC as at December 31, 2019, using the adjusted net asset approach. Your response should be no longer than one half of a page, excluding any Excel files. Task #4 Compare the two valuations and explain why there is a difference in the equity values for MBC. Conclude on the equity value of MBC. Your response should be no longer than one page, excluding any Excel files. Finance — Integrated Problem 6 Problem 3 / 5 Appendix I Milltown British Columbia Inc. Extracts from non-consolidated income statement and statement of retained earnings For the years ended December 31 (Under ASPE) (in $’000s) 2019 2018 2017 2016 (audited) (audited) (audited) (audited) Sales Panel products 8,471 8,171 7,617 4,017 Operating expenses: Cost of sales, excluding depreciation 6,565 6,333 5,865 3,053 Selling, general, and administrative 677 677 623 512 Depreciation and amortization 445 411 396 414 7,687 7,421 6,884 3,979 Operating income 784 750 733 38 Interest expense 150 152 154 20 Earnings before taxes 634 598 579 18 Income taxes expense 159 150 145 4 Net income 475 448 434 14 Retained earnings, beginning of year 896 448 14 — Net income 475 448 434 14 Retained earnings, end of year 1,371 896 448 14 Finance — Integrated Problem 6 Problem 4 / 5 Appendix I (continued) Milltown British Columbia Inc. Extracts from non-consolidated balance sheet As at December 31 (Under ASPE) (in $’000s) 2019 2018 2017 2016 (audited) (audited) (audited) (audited) Assets Current: Cash 1,170 736 524 268 Receivables, less allowance 488 470 418 242 Inventories 657 634 618 359 Prepaid expenses 123 123 143 134 2,438 1,963 1,703 1,003 Property, plant, and equipment, net 5,977 5,927 5,473 5,282 Total assets 8,415 7,890 7,176 6,285 Liabilities Accounts payable and accruals 1,044 994 728 271 Long-term debt 2,000 2,000 2,000 2,000 3,044 2,994 2,728 2,271 Shareholders’ equity Share capital 4,000 4,000 4,000 4,000 Retained earnings 1,371 896 448 14 5,371 4,896 4,448 4,014 Total liabilities and shareholders’ equity 8,415 7,890 7,176 6,285 Finance — Integrated Problem 6 Problem 5 / 5 Appendix II Additional information for valuations prepared by the CFO of MFL • Relevant financial information for 2016 to 2019: o Additional one-time overhead costs of $175,000 were incurred in 2016 to configure the plant and establish the operations. o The management committee made payments to MFL to cover oversight, monitoring, and administrative support. However, MBC is now largely self- sufficient and will no longer be paying these amounts. The amounts were $80,000 in each of 2017 to 2019 and $40,000 in 2016. o In 2018, MBC suffered a large theft of $75,000 worth of finished goods inventory while in transit to a customer. The company does not carry insurance coverage to cover losses. • Sustaining capital expenditures, net of expected tax shields, have been estimated to cost $300,000 per year. Investments in working capital are expected to increase by $10,000 per year to support growing levels of sales. • MBC’s income tax rate is 25%. • Based on comparable data, the weighted average cost of capital for private companies in this industry and of this size is 8%. • MBC has vacant land that is not currently being used. • The CFO has determined that MBC has excess cash of $500,000, which will be either invested in short-term marketable securities or paid out as a dividend. • For all assets and liabilities, their net book value equals fair market value except for the property, plant, and equipment as follows: (in ’000s) Net book value Original cost Fair market value Undepreciated capital cost Land — vacant $ 250 $ 250 $ 800 Land 350 350 1,000 Building (4% capital cost allowance rate) 2,140 2,600 2,800 $1,970 Equipment (20% capital cost allowance rate) 3,237 $4,700 2,700 $1,680 $5,977 $7,300 • Selling costs are 4% of fair market value. Finance — Integrated Problem 6