Reference no: EM13350479

Fred arrived at Salmon River early on Sunday, October 11, and instantly met with Eileen. -Me first thing we must do is to evaluate our financial position," he told her. "I guess we can start by reviewing the financial statements," she replied. I just received them on Friday." Fred examined the financial statements, which are attached as Exhibits 2 and 3. The subsequent additional information came to light during the conversation:

1. The capital improvement phase of the project was complete.
2. The bank overdraft position was effectively unchanged since the financial statement date. Thus, the bank manager had currently asked Eileen to present a plan to retire this amount in an orderly manner Eileen felt she would need to have this plan ready within a week.
3. The accounts payable amount included $28,625 due to the contractor. Eileen admitted that this should have been paid from the proceeds of the second term loan, but there were several pressing operating accounts which took precedence.
4. Payroll deductions had not been remitted for two months and now totaled $5,137. Provincial sales tax was also unpaid and totaled $3,240. These were similar to the amounts included in the accounts payable figure on the Balance Sheet.
5. After the Inn had opened for business, Eileen felt that she did riot have the time to supervise all of the day-to-day operations. Within the community, she was able to locate a lady who had had several years of experience in the hospitality industry. Eileen thought that the $7,000 salary paid this person was worthwhile, unfortunately, the lady had newly moved out of the community as her husband had been transferred.
6. The revenues for both room rentals and restaurant sales were well below projections. There were eight rooms which rented at an average of $40 per night. Fred evaluated that there had been 100 days between the Inn's opening and the end of August, a potential rental revenue of $32,000. On that basis, the occupancy rate appeared rather low Eileen felt, thus, that the occupancy rate should have averaged about 60%, although she did not have any actual statistics to confirm this. She was also very disappointed by the restaurant sales. When the menu had been drawn up originally, all food purchases had been marked up by 150% to arrive at selling prices. She felt that about $5,000 of the amount disclosed as "purchases of food and supplies" related to non-food items. Even at that, thus, the margin appeared too low.
7. Wages and benefits were also a cause for concern. Fred felt that, even with the manager's salary deducted, this amount was excessive. Eileen became a little defensive, pointing out that her two children had been paid about $6,000 between them during the Inn's operating period. After further discussion, Eileen admitted that she had realized that there were too many employees. Thus, she felt that because of the poor fishery in the area a number of people in the community had not worked sufficient time to qualify for unemployment insurance benefits. In her opinion, employing these people for "a few weeks" was a good public relations gesture.
8. Most of the other item on the list reflected normal operating costs for the year.

The Decision Options

Eileen and Fred agreed that the options open to the owners were as follows:

1. Do nothing Because of the unpaid accounts and bank overdraft, the bank would likely place the company into receivership. All of the money they had already invested would then be lost.
2. Look for another investor to participate in the company with them or sell the whole company to someone else.
3. Invest an additional $70,000 to pay the outstanding accounts and repay the bank overdraft.
Both Eileen and Fred realized that in order to make an informed decision they needed additional information, particularly a set of forecasted financial statements. With this in mind, they prepared the subsequent information:
1. Between the peak occupancy season of mid-June to mid-September the rooms should operate at 70% capacity. During the rest of the year the occupancy rate would be about 40%
2. Restaurant sales should approximate $100,000 for the year.
3. Should the company operate over the next year, Fred and Eileen had agreed not to receive a salary from the Inn. Fred insisted that if this was the case, there be no official manager and that Eileen's children, at $10,000 each, and a cook at $20,000, be the only permanent employees. During the peak summer season, three additional employees could be added at the minimum wage of $4.75 per hour. Also, all employees would receive benefits at approximately 15%. per hour.

Summary

Both Fred and Eileen believed that the decision to be made was a critical one, and the importance of it could not be overstated. As Fred put it, "after all, raising an additional $70,000 will not be easy. Eileen will have to remortgage her home. I can find my share in my existing engineering business, but it will certainly reduce my flexibility in carrying out certain projects which I had planned for next year."

Required:

Analyze the company's operations, results and future. Show the three options available to Eileen and Fred. Which one would be in the best interest of the business? Which one would be in the best interest of Fred and Eileen?

                                                             Exhibit 1

                                                  Approved Funding Proposal

Capital Costs
	Land	$10,000
	Building purchase	50,000
	Renovations	150,000
	Furniture	25,000
	Equipment	35,000
		$270,000
Financing Package
	Bank of Nova Scotia term loan	$47,000
	Shareholders' advances	54,000
	Contribution under the Fisheries
	Alternative Program	169,000
		$270,000

Exhibit 2 Salmon River Inn Limited Balance Sheet As of August 31, 1992

ASSETS
Fixed, at net book value
	Land	$10,000
	Building	264,310
	Furniture and equipment	94,462
		368,772
	Less: Contributions from ACOA	169,000
		$199,772
LIABILITIES
Current
	Bank overdraft (secured by personal
	guarantees of owners)	$ 9,957
	Accounts payable	54,327
	Current portion of long-term debt	9,500
		73,784
Long-term debt
	Bank of Nova Scotia, repayable over
	10 years at prime plus 2%	84,985
Shareholders' advances, interest-free
with no repayment terms		99,998
		258,767
SHAREHOLDERS' EQUITY
Share capital
	Authorized: 1000 no par value shares
	Issued: 100 shares	100
	Retained earnings (deficit)	(59,095)
		(58,995)
		$199,772

Exhibit 3 Salmon River Inn Limited Statement Of Loss and Deficit For the Period Ended August 31, 1992

Revenues
	Restaurant	$ 34,647
	Room rentals	9,695
		44,342
Expenses
	Food and supply purchases	25,610
	Wages and benefits	33,315
	Advertising and promotion	3,367
	Utilities	7,712
	Insurance	3,328
	Interest and bank charges	7,112
	Office supplies	1,246
	Vehicle operating	997
	Accounting	1,575
	Other operating expenses	4,488
	Municipal taxes and permits	1,440
	Depreciation
	- building	7,056
	- furniture and equipment	6,191
		103,437
Net loss for period and ending deficit		$ 59,095