MGFB10H3 Lecture Notes - Sole Proprietorship, Financial Statement

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28 Mar 2014

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Chapter 2: janice borrowed ,000 from friends and family to start her company (a sole proprietorship). Recently, business has been poor, and janice has decided to cease operations and liquidate the firm. She expects to obtain ,000 from selling the assets of the company. When operating as a sole proprietorship, all of the assets of the company belong to the owner; the company"s debts are also the owner"s debts. Janice will have to pay her friends and family (the debt-holders) the full ,000 they are owed. The ,000 obtained from selling the assets will first be used to pay the debt-holders what they are owed. Any remaining funds will be paid to janice. The debt-holders will receive the entire ,000 obtained from selling the assets. The remaining ,000 that they were owed will not be paid because the company has no more funds.

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Bob, Chad and Dylan had been dreaming of this day for the past six years; ever since they first met in an introductory economics course in college. For several years they had been pooling their money and buying Arizona Lottery tickets dreaming that one day they would win big. They realized that the lottery was considered by many to be a voluntary tax on the statistically challenged. But miraculously they now sat at their favorite local âwatering holeâ holding the winning ticket that meant they would split âThe Pickâ jackpot of $6 million. What a great feeling! Now they just needed to decide if they wanted to take their winnings as a lump sum now or to be paid over the next twenty in installments. Bob had been a political science major in college but things hadnât worked out as he anticipated when he was a student. He had entered the job market at what looked now to be the bottom of the economic downturn following the housing crisis in the U.S. Bob believes he did not start his job search soon enough and found suitable openings virtually nonexistent. He was currently working part-time at an organic farm and still living at home which cramped his style consider-ably. He has $150,000 in college related loans (7% interest rate) which he cannot service based on his annual taxable income of $15,000. His share of the jackpot would allow him to be debt free and change his life for the better without doubt. Chad had been more fortunate than Bob. He had applied himself in college and earned a master of accounting degree with an emphasis in taxation. After graduation he immediately went to work for one of the international accounting firms and was now earning a taxable income of $100,000 in spite of the economic issues facing his friend Bob and the country as a whole. He too had debt but not from student loans. Chad had purchased a very nice home in Anthem, Arizona for approximately 50% of what it had sold for three years earlier when built. He had a $250,000 mortgage on the home, at a 4% interest rate, which he saw little reason to pay off since he anticipated significant inflation in the near future. Of the three friends Dylan was by far the most successful. Dylan had majored in finance and had excelled. When he graduated, although he had several attractive offers in the financial services industry, he decided to go into the family business. The company which his father and uncle had started nearly 50 years ago had done amazingly well in the downturn and since he was the only child/nephew they were rewarding him handsomely. He had been reluctant to tell Bob but he was on track to receive to- tal compensation (including bonuses) that yielded a taxable income of $300,000 this year. Unlike his friend Bob, Dylan was frugal and had taken on zero debt. He was pleased with the trioâs good fortune but he didnât think the windfall would change his life all that much. A few days later when the euphoria of winning was subsiding the three friends met again at the same establishment. All four were obviously in good spirits and were looking forward to presenting their winning ticket to Arizona Lottery officials. Chad started the conversation by telling Bob and Dylan that he had taken the initiative of doing some basic research on how âThe Pickâ worked and what the payout options were. Bob, proud of his forethought, produced an article he had saved years earlier from the Arizona Daily Star with the headline âLump-sum Lotto Payout is Best, Experts Say.â Bob excitedly told his buddies that the experts were local CPAs and that clearly the lump-sum payout was âthe way to go.â Dylan said he wanted to hear what Chad had found out since he had gone to the effort of looking into the specifics. Chad (being a tax accountant) had prepared a summary of his research which follows: âA percentage of the proceeds from the sale of Lotto tickets are allocated to a prize pool. The size of the Jackpot that is prominently advertised, six million dollars in this instance, is actually only an estimate. The advertised amount is the sum of the estimated annuity1 payments, without consideration of the time value of money, which Lotto officials believe can be purchased from the prize pool. If the winner chooses the annuity payout multiple insurance companies submit bids. Officials award the bid to the insurance company that offers the largest annual payments in return for the prize pool amount. The insurance company with the best bid typically offers a rate that is near the long term U.S. Treasury Bonds rate (currently 3%). If the winner chooses the Lump Sum payout they simply receive the prize pool amount; the amount that would have been used to buy the annuity.â 1.The term annuity is actually a misnomer. Since the payments are made by the insurance company at the beginning of each of twenty periods it is an annuity due. After reading the summary Bob said he didnât see how this related to the decision that had to be made since he didnât see anything that changed the preferred option being that the lump-sum payout is best. Chad acknowledged that Bob was probably correct but he still wanted to ârun the numbersâ and suggested that Bob and Dylan should do the same. Chad reminded them that they needed to consider the tax consequences of the payout schema and then provided the following schedule of federal income tax rates and reminded them that the state tax rate was an additional 5%.Bob rolled his eyes but said he would get right on it. Dylan thanked Chad for the information and they agreed to meet again tomorrow to decide on the best course of action.

Questions 1. Prepare a personal analysis of the payout options for Bob, Chad and Dylan including their net income after taxes. Designate the preferred option for each individual and explain why.

Background

Dr. Eileen OâToole bought the assets of the old âOK CareHospitalâ in 2010 believing the former company had gone out ofbusiness because of poor management rather then issues relating tomarket demand. The new âExtra Care Hospitalâ was a 24/7 emergencyhospital and the only one in the County. The closest direct rivalwas over 45 minutes in any direction. With many 80 hour weeks andthe help of friends, the new Extra Care Hospital was building astrong reputation in the community helping to overcome some of thenegative impact of one of the worst recessions in US history.

Dr. OâToole immediately faced an unexpected issue of equipmentmaintenance/failure. While the new company had bought all theassets of the former company, this did not include the warranties,guaranties and service agreements that the former company hadreceived when the equipment was originally purchased.

Almost all clients/patients require blood work in earlydiagnosis and treatment. To perform these tests the company owned athree year old âItechâ Blood Analyzer that had recently begunacting up. It had been down for two days and the less sophisticatedback-up machine was showing signs of failure. If a new machine wasnot acquired or the current one repaired, the hospital would beunable to perform basic diagnoses.

Blood Analyzer Situation

When Dr. OâToole called Itech to have the machine repaired, shelearned that there was neither a service agreement nor a warranty.Furthermore, the software on her machines was out of date.

Before signing and paying for a new service agreement, Dr.OâToole decided to contact other equipment distributors about theirmachines. Dr. OâToole contacted a competitor, âHesterâ, andinquired about what kind of deal Hester could offer on a newmachine. The next day, a âsampleâ Hester DC-70 blood analyzerarrived for Extra Care to use while their Itech machine wasdown.

The hospital staff were trained the same day and were excitedlytalking about the new Hester machine when Dr. OâToole came in laterthat day.

Razors and Blades

In the medical / healthcare industry many procedures requirespecial equipment and âconsumablesâ that would only fit specificmachines. For example, a Hester blood analyzer required specificcartridges that uniquely fit its machine and contained specialchemical formulas that in conjunction with the analyzer actuallyperformed the various tests on the blood sample. Itech sold adifferent cartridge that only fit its analyzers. Thus the inventoryof âpanelsâ or cartridges that Extra Care possessed only workedwith Itech machines. Needless to say, both Itech and Hester madesubstantial profits on their consumable business. Once theirmachine was purchased, the customer had no choice on their vendorfor the related consumables. Much like once you buy a particularrazor you could only buy blades from the same company.

Many industries use this âRazor and bladeâ or ârecurringrevenueâ business model. For example, Ink Jet printers are oftenpractically given away so as to build the demand for the highlyprofitable ink cartridges.

Hesterâs Blood Analyzer cartridges were less expensive then wereItechâs, as the volume of usage grows with the business, the gap inoperating cost of the two machines grows as well.

Itech Estimated Costs

Cost to purchase: $ 25,999 (in year 8)

Life Expectancy: 10 years

Annual Service Agreement: $1,300

Cost of Annual Calibration (varies with use): $400 (currentyear)

Estimated cost of consumables (varies with volume/usage):$15,114 (Year 1)

Cost to install new linking software: $500 (waved)

One time credits/discount awarded for other Itech consumables:$2,000

Extra-Care Hospital currently earns $50,000/yr in Blood AnalysisRevenue

Hester Estimated Costs

Cost to purchase: $ 16,694 (the price after the 20% discount

Life Expectancy: 10 years ï¡ Annual Service Agreement: $750

Cost of Annual Calibration (varies with use): $175 (currentyear)

Estimated cost of consumables (varies with volume/usage):$13,434 (current year)

Cost to install new linking software: feature not available

Extra-Care Hospital currently earns $50,000/yr in Blood AnalysisRevenue

The Alternatives

Option 1 â Stay with Itech 3 year old machine: Itech will giveExtra Care a one time $2000 of credits for the purchase ofconsumables over the next 2 years and will provide two newservices: (1) integration into the companyâs hospital managementsoftware to automatically link blood tests with client records andinvoices thus eliminating the need for staff to enter the chargesthemselves, and (2) a link to Itech laboratories allowing automatedsoftware updates and Itech lab results to be downloaded to companyrecords. Additionally, Itech will bring the current Extra Caremachine up to current specs or replace it with one that is. Theblood analyzer needs to be calibrated at a frequency related tousage. High use requires more frequent calibration. Itech willreduce the price of the chemicals needed for the calibrationprocess.

Option 2 â Purchase the Hester DC-70 ï¡ Hester has reduced thepurchase price by over 20%. Hesterâs machine has a lowercost of calibration. Hesterâs machine uses lower costconsumables.

Extra Care Hospital growth is expected to grow at about 10-15%per year with a direct 10-15% growth in blood tests.

Questions

1. Dr. OâToole wonders if she should take this opportunity toswitch from the current 3 year old Itech blood analyzer to the newHester DC-70. What would be the financial implications over thenext 10 years?

2. Also, she wonders what the operational considerations mightbe with regards to staff training, dependability, etc.

3. Dr. OâToole read recently that, on average, hospital staffforgets to bill for about 15-20% of the services provided. If herstaff was similar to the industry norm then would the Itechsoftware link to the Extra Care Hospital management software leadto an increase in revenue? If so, how would that 15-20% increaseaffect her decision?

4. Dr. OâToole wonders what other factors should be included inher analysis?

Financial Assumptions

10 year analysis period

Cost of capital (discount rate): Low risk investments: 10%Medium risk investments: 15% New ventures other high risk: 25%

Replace Itech in year 8 for $25,999

Hester machines last for 10 years

No impact for inflation, work in constant dollars

Cost of calibration and consumables increase with revenueincreases.

No increases to cost of annual service contract

whiteturtle638

I need a diferent point of view and someones opinion on this article.

Reforming the U.S. system of collective bargaining Collective bargaining procedures and relationships between labor and management must reflect less conflict, more cooperation as the Nation's economy struggles to meet international competition and domestic needs D. QUINN MILLS Rules as a productivity drain Rules alone cannot ensure that an organization will perform well. They may keep it from dissolving into self-defeating open warfare, but often do not permit it to achieve its potential. An organization which depends upon adherence to a myriad of rules will always be vulnerable to competition from other organizations which operate in a more consensual and cooperative fashion, even when the latter have fewer resources. And, although an organization of rules may sometimes pull it-self together to respond to an emergency, this need not necessarily occur. It follows, then, that primary dependence on establishing and enforcing rules is a very poor way to run an economic enterprise. The existence of a multitude of rules, many of which attempt to "stretch the work" to maintain jobs in ways reminiscent of depression-era tactics, constrains productivity and raises costs. For example, maintenance classifications may prohibit an employee from doing incidental work outside the strict limits of his or her trade; multiple job classifications may exist even where a person in a single combined classification could do the work effectively, without undue effort and stress; and, job classifications may be perpetuated although technological change has rendered the incumbents' work trivial. Other restrictions may limit the amount of work a person may be assigned, such as permitting a mechanic to open only two flanges. The location of materials and inventory may be restricted by contract or past practice to retain jobs in now-inefficient areas of the plant. In some cases, rules may prohibit employees being assigned work during breaks, and simultaneously prohibit supervisors from doing the employees' work, so that emergencies occurring at coffee breaks or lunchtime cannot be legally handled under the agreement. Over time, rules tend to become increasingly costly and constraining as technology, materials, products, and other aspects of production change. Even rules which made great sense at first become out-of-date under changing conditions. But the rules are difficult to change, and particular employees may be further benefited the more outdated the rules become. Sometimes a company can pay a high price and "buy the rules out," or a union can persuade some workers to give up favored positions for the good of the membership as a group. But often, change cannot be accomplished without a bitter struggle between management and labor. Furthermore, the rule making process promotes a set of attitudes which are inimical to successful enterprise. The existence of the rulebook encourages both management and labor to assert their rights under the contract, rather than to attempt to work out problems. It gives rise to "shop-floor lawyers," rather than problem solvers. It fosters conflict and controversy. It undermines trust. To a large degree, it seems that unions have become captives of their origins. Born in adversity and conflict, they continued to act as opponents of management even when their strength had become much greater. In some instances, unions have created thickets of rules in which to immobilize management, just as spiders build webs to ensnare prey. But when the thickets of rules have crippled productivity, the unions have discovered themselves to be caught alongside management in the trap. Plants have declined in competitiveness, and jobs have been lost. The unions have discovered too late that a snare is no less a snare because they have set it themselves. A prescription for change In a recent survey conducted by the Harris organization, a majority of the general public professed the belief that unions contribute less than they once did to the growth and efficiency of business. Not surprisingly, only 15 percent of union leaders agreed with this judgment.' The need for unions to assist companies in the light of increased foreign competition is apparent to the public. To the inhabitants of the Snow Belt, it is similarly evident that unions should cooperate with local business to stem the outflow of industry and jobs to the South and West. Public perceptions of a productivity problem are supported by Bureau of Labor Statistics estimates, which show particularly sluggish growth in output per labor hour after 1973.3 Collective bargaining practiced primarily as rule making has become self-defeating for both unions and management. It interferes with management's efficient operation of the enterprise, and ensnares employees with legitimate grievances in a web of red tape. It also contributes to the vehemence of employer attempts to resist union organization drives. Study after study of U.S. managers has shown that managers fear the imposition of restrictive work practices far more than the higher wages and benefits which unionization may bring. Companies' efforts to make competitive operations out of older plants often fail because changes in current work rules take the form of additional complex rules which do not provide the flexibility needed to turn a facility around. What management really needs is fewer rules altogether, and willing cooperation from the work force. The union, for its side, needs a management sensitive to the needs of people. Both are very difficult to obtain in the U.S. labor relations environment.

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MGFB10H3 Lecture Notes - Sole Proprietorship, Financial Statement

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