Corporate finance

WA’s shop rate is $70 per hour, which is low compared to the industry standard of $85. All parts are resold at cost. Service work is paid for immediately by the customer.

Twenty-five per cent of all sales are for cash, but the remainder require financing. WA offers customers three- and five-year financing plans, but these sales agreements are immediately resold to Great Plains’ financing unit that repackages them and sells them as asset-backed securities. This process takes approximately 60 days, and WA is paid in full at that time. The dealers have been lobbying Great Plains to reduce this payment period to 30 days through faster processing.

WA’s 50 covered storage lots are rented at $300 per unit per quarter, which WA promotes as the “best rate in town.” In the Kamloops market, rates for similar units average $450 per unit and the customer must commit to a one-year lease. Payment is received electronically from customers on the last day of each quarter.

Cost of Sales

The 2017 wholesale prices for Great Plains RVs are:

The company’s two mechanics are paid on piece rate and receive $40 per service hour. Both mechanics are fully employed in quarters 2 and 3, but are underutilized the rest of the year. WA has been exploring ways to improve efficiency in the service area.

As engines in all three RV models are standard General Motors designs, parts can be sourced locally on a just-in-time basis, therefore, negligible parts inventories are required. Supply inventories are also minimal. For planning purposes, WA finds that parts and supplies average 80 per cent and 15 per cent of service revenue.

WA purchases all of its RVs on terms net 30 from Great Plains. WA maintains inventory levels at 40 per cent of next quarter’s sales for each model of RV. The dealer relations representative from Great Plains says other dealers maintain inventory of approximately 30 per cent of next quarter’s sales on average. The representative also indicates that Great Plains’ credit terms are sometimes extended to net 60 to aid struggling dealers or help finance expansions.

Beginning inventory consists of two Freedom models, seven Independence models, and eight Autonomy models. Wholesale prices were the same as in 2016.

Other Expenses

Other than inventory purchases and depreciation, all expenses are paid as incurred.

WA has been considering paying its sales staff on a straight commission basis to improve results. The number of salespeople will likely decline as poorer performers see their incomes drop, but the remaining sales people should be able to maintain their earnings.

Capital Budget

WA has prepared a list of capital acquisitions that it plans to make in 2017:

The equipment is needed to open the remaining two service bays and additional furniture is required for the sales offices. The equipment purchases can be delayed if necessary. All assets are depreciated on a straight-line basis and the residual value is assumed to be negligible.

Financing

WA has negotiated a $5,750,000, 5.70 per cent line of credit with the Royal Bank. The loan is secured by the company’s current assets – it can borrow no more than 40 per cent of the value of its inventory and 80 per cent of its accounts receivable. Interest is paid at the end of each quarter and all repayments or drawdowns are made at that time.

Purchases of fixed assets can be financed with a term or mortgage loan with the Royal Bank. The bank is willing to lend 60 per cent of the value of equipment and 75 per cent of the value of real estate. Loans are paid down monthly on a straight-line basis over the life of the asset and generally cannot be paid early. Asset acquisitions and interest and principal payments are made at the end of the quarter only. The term loan currently has a fixed interest rate of 7.35 per cent per annum. The Royal Bank allows the company to make an additional principal payment equal to 15 per cent of the balance of any term and mortgage loan at the end of the fourth quarter each year.

The Royal Bank requires that WA maintain a current ratio of 1.50 each quarter and an annual times interest earned ratio of 5.00 (i.e. it is only calculated in the fourth quarter based the yearly totals) as well as submit audited quarterly and annual financial statements for review. Also, the line of credit must be paid down to zero once per year to ensure the company only uses its line of credit to finance its seasonal build up in net working capital.

WA attempts to maintain a long-term debt to total-capitalization ratio of 25.00 per cent although it is not a condition of any of its bank loans.

Company policy is to maintain a cash balance of $575,000 at the end of each quarter. Surplus cash balances can be invested in a 3-month term deposit at 1.35 per cent per annum. Funds are invested or withdrawn at the end of the quarter only and income is paid out at this time. Based on past experience, the company was studying whether a cash balance of $500,000 could be sufficient.

Income Taxes

The corporate tax rate is 16 per cent.

Distributions to Owner

Current loan agreements limit Zelanko’s dividends to $300,000 per year. WA currently pays this amount to Zelanko in four equal monthly installments, but she indicated it could be reduced to $150,000 per year if necessary.

Potential Expansion

Great Plains approached Zelanko about opening another dealership in Kelowna in 2019. She thinks this is a tremendous opportunity given that city’s high average income and its emergence as a major Canadian retirement destination. Based on her experience in Kamloops, Zelanko feels a net investment of $6,750,000 would be needed and that 55.0 per cent could be financed through the Royal Bank.

Zelanko was very anxious to pursue the Kelowna expansion so she immediately met with her accountant. Ali McPherson, CPA, stressed that the economy in B.C. was currently doing well but that continuing low oil prices and rising interest rates may lead to a decline in consumer confidence next year that could significantly affect RV sales. She also indicated that WA did not meet all its loan conditions last year, its profitability ratios were significantly below industry averages and it was over leveraged. Recent data from Statistics Canada indicated an industry average net profit margin of 2.85 per cent, total assets turnover of 3.75, rate of return on assets of 10.67 per cent, rate of return on equity of 25.55 per cent, long-term debt to total capitalization ratio of 25.00 per cent, and times interest earned ratio of 5.00 - all ratios are calculated for the year and are based on year end information.

Despite McPherson’s cautious tone, Zelanko still wants to somehow purse the expansion. She knows that other new Great Plains dealers can be found quickly if she hesitates, so being able to open a new location by 2019 is imperative. How can she address McPherson’s concerns about profitability and over borrowing? Will she be able to find the equity for the proposed expansion or should she pursue a more prudent growth strategy given the current economic outlook?

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