May, 2017

PACIFIC GROUP SPICE

COMPANY
FIN300 REPORT GROUP 3

MEMBERS:
1. Khng Minh H
(leader)
2. ng Th M Hnh
3. Nguyn Th M
Hoa
4. Nguyn Th Thi
H
5. Chang Dayoung
6. Hunh Nht H
7. Trnh Th Thu
Phng
 Advanced Accounting 56 Fin300 report Group 3

INTRODUCTION

Pacific Grove Spice Company was opened in the early 1980s as a small specialty grocer in
California. In the late 1990s the company hired Debra Peterson in the retail distribution
sector of the company. She then moved into the position as the Chief Operating Officer. The
company continued to grow and the founders did not want to actively manage the company
any longer.

The company appointed Peterson as the president and CEO of Pacific Grove Spice Company.
The sales and profits continued to increase rapidly. Even though the company was profitable,
retained earnings were not sufficient to fund the growing of assets.

In 2011 the bank that the company does business with was not comfortable with the total
amount of interest-bearing debt that Pacific Grove Spice Company had on their balance sheet.
The company was showing debt in access of $37 million. The bank informed the company
that it wanted a plan of action to reduce the interest-bearing debt to fewer than 55% of total
assets and they also wanted to see the equity multiplier down to less than 2.7 times by June
30, 2012. Pacific Coast needs to meet this requirement that the bank is giving them because
they are refusing to lend additional credit to Pacific Grove unless this is met.

In this report, we will discuss 3 questions:

1, Should Pacific accept an offer from a cable cooking network to produce and sponsor a
new program? This opportunity would increase the companys sales, profits, and cash flow
above the presented in Exhibit 1, but would require investment in television equipment,
capacity and working capital
2

2, Should Pacific raise new equity capital by selling shares of common stock?................ .3

3, Should Pacific acquire High Country Seasonings?..............................................................5

1
 Advanced Accounting 56 Fin300 report Group 3

Question 1: Should Pacific accept an offer from a cable cooking network to produce and
sponsor a new program? This opportunity would increase the companys sales, profits, and
cash flow above the presented in Exhibit 1, but would require investment in television
equipment, capacity and working capital.

Pacific need more funds for assets to support its high growth of sales. Right now, its
financing is provided by a large bank which seem to be concerned about the large interest
bearing debt on balance sheet of the Pacific. Pacific is pursuing few options to decrease its
debt and to fund its growth. The company is looking at a cooking network to produce and
sponsor a show would provide good sales increasing at the rate of 5%.
At first we thought it would be a good option for the company, then we saw that this
opportunity would increase the companys sales, profits, and cash flow but at the same time
Net Working Capital also increase. That means the project has negative cash flow for both
year 0 and year 1.
According to Exhibit 3, you only take into account the IRR and the NPV it is positive at
41.28%, this option would be a good project. However, Pacific need a total of 1,440,000 to
initially start this project. If the WACC for Pacific was 10% the expected NPV of the project
would be about $3,274,147, so the project be quite profitable. Even at higher WACC of 20%
and 30%, NPV is positive which indicated the project to be quite outstanding to earn cash
flows.
However, it is clear from Exhibit 3 that this project has the cash flow stream that is not
sufficient to decrease the financial leverage of the Pacific that the bank is asking for. By
adding of the project to the net worth of the company in 2011 does not change the financial
leverage of the company by much. There is a large risk in this project not even taking into
account the actual performance. The TV program could be a total flop. Having a connection
with a TV network could benefit Pacifics brand with promotions however, Pacific lacks
knowledge in the TV network industry. By moving forward with this project would put more
interest-bearing debt on the balance sheet. This project does allow for some good return, but
it does not meet the financial requirements that the company needs to satisfy the bank.
If the company really wanted to move forward with this option even though we do not
think it is a good idea, they could gain capital and not increase debt by selling shares of the
company. However, current shareholders may not like this option.

2
 Advanced Accounting 56 Fin300 report Group 3

2) Should Pacific raise new equity capital by selling shares of common stock?

In this case, Pacific Grove Spice Company was having troubles and needing money to invest.
However, only bank can help them. The bank required that company had to have Debt to
asset ratio less than 55% and Equity multiplier less than 2.7 times before 30/6/2012.
At that moment, Pacific Grove Spice Company has 1,165,327 shares outstanding at $ 32.60.
Investment group was willing to purchase 400,000 shares at $27.50.
Shares of stock to be sold 400,000
Price adjusted for floatation $27.50
Increase in assets and equity 11,000,000

Rate of return on equity:

Cost of Equity = Risk free rate + (Equity beta coefficient x Market risk premium)
= 4.25% + (0.85 x 7%)
= 10.2%
Ratio analysis:
2011 2012
Interest bearing debt 37.172
Debt ratio = = 62.35%
Total assets 59.620
37.172
= 52.64%
70.620

Total Assets 59.620

Equity Multiplier = ' = 3.47
Total Stockholde r sEquity 17.198
70.620
= 2.50
28.198

Debt ratio (2012) = 52.64 % < 55%

Equity Multiplier (2012) = 2.5 times < 2.7 times
Suitable with requirements of the bank.
To make decision that Pacific should sell shares of common stock or not, we should consider
some advantages and disadvantages of this action:
Advantages
No New Debt
A major advantage of selling partial ownership is you don't have to take on new debt. Loan
financing comes with repayment requirements and an interest rate that leads to finance
charges until the loan is repaid. In some cases, you could pay on the loan for years, which
means you not only repay what you borrowed, but hundreds or thousands of dollars in fees on
top of that. Companies that take on too much debt leverage could eventually face business
failure, or even bankruptcy.
Shared Risk
Another advantage of selling stock to raise funds is that if your business fails, you do not
have to pay the money back to investors. You could potentially get sued if you were negligent
in your use of the money. However, new investors take on the same risk of loss that you do
when you invest in your own business. If you want to minimize your own potential for loss
on a new investment, equity financing is the way to go.
Disadvantages

3
 Advanced Accounting 56 Fin300 report Group 3

Loss of Ownership
A major disadvantage of selling shares of stock to raise funds is that you also give up some
level of ownership. Investors buy into your company hoping to profit if the company
succeeds and generates profits down the road. Some small business owners seek equity
financing without fully contemplating the realities of a new ownership structure. Giving up
too much of your company early on to get investments can become frustrating when your
profit from your idea and hard work is diminished. Some venture capitalists ask for
participating preferred stock. Preferred stock takes precedence over common stock shares
owned by founders, which means preferred shares are paid first on a sale of the company.
You usually receive less return in this case.
Loss of Control
Along with the loss of ownership, you also relinquish some control over your business
through equity financing. Some investors insist on having a representative work for the
business or become part of your board. The higher the ownership stake, the more control over
the direction and decisions of the company the investor usually wants. Spreading out your
stock sales to a few investors in limiting shares as much as possible can help reduce your loss
of decision-making power over your company.

In this case, selling shares of common stock have more advantages and fit with requirement
of the bank then Pacific should sell shares of common stock to raise new equity capital.

4
 Advanced Accounting 56 Fin300 report Group 3

3, Should Pacific acquire High Country Seasonings?

First, well take a look at the 2 companies consolidated balance sheet for 2011
Consolidated Financial Statement

Assets 06/30/11 06/30/11 Consolidation

Cash $4.102 $0.673 $4.102
Accounts Receivable 16.632 3.609 $16.632
Inventories 11.878 2.360 $11.878
Prepaid Expenses 0.969 0.263 $0.969
Total Current Assets 33.581 6.905 $40.486
Goodwill $8.616
Net Property & Equipment * 22.400 4.424 26.824
Other Long-Term Assets 3.639 0.527 4.166
Total Assets 59.620 11.856 80.092
Liabilities & Owners' Equity
Bank Notes Payable $13.442 $0.902 $14.344
Accounts Payable 3.905 0.931 $4.836
Current Portion of Long-Term Debt 1.483 0.000 $1.483
Accrued Expenses 1.345 0.299 $1.644
Total Current Liabilities 20.175 2.132 $22.307

Long-Term Debt 22.247 0.000 22.247

Total Liabilities 42.422 2.132 44.554

Common Stock 6.881 4.584 20.081

Retained Earnings 10.317 5.140 15.457
Total Shareholder Equity 17.198 9.724 35.538

Total Liabilities & Net Worth 59.620 11.856 80.092

Goodwill Calculation
Total value of Investment $13,200,000.00
Book Value of stock 4,584,000.00
Goodwill 8,616,000.00

Peterson anticipated that cash would equal 20 days of operation expenses, accounts
receivable would be 75 days of sales, both inventory and net property equipment would turn
over 4 times, prepaid expense would be 1,2% off sales and other long-term assets would
equal 4.5% off sales

5
 Advanced Accounting 56 Fin300 report Group 3

For liability accounts, account payable would equal 30 days of COGS, and accrued expenses
would be 1.66% of sales

Pacific Grove Spice Company Balance Sheet after acquiring High Country Seasonings
Assets 06/30/12 06/30/13 06/30/14 06/30/15
Cash $5.397 $6.048 $6.668 $7.809
Accounts Receivable 22.988 25.706 28.288 30.653
Inventories 16.502 18.296 20.134 21.818
Prepaid Expenses 1.343 1.501 1.652 1.790
Total Current Assets 46.230 51.551 56.742 62.070

Net Property & Equipment * 29.855 33.407 36.783 39.875

Other Long-Term Assets 5.035 5.629 6.195 6.713
Goodwill 3.400 3.400 3.400 3.400
Total Assets $84 $94 $103 $112
Liabilities + Owners' Equity
Bank Notes Payable $16.792 $18.266 $19.562 $21.181
Accounts Payable 5.426 6.015 6.620 7.173
Current Portion of Long-Term Debt 1.614 1.751 1.842 1.869
Accrued Expenses 1.857 2.077 2.285 2.477
Total Current Liabilities 25.689 28.110 30.309 32.700

Long-Term Debt 24.204 26.258 27.614 28.028

Total Liabilities 49.893 54.368 57.923 60.728

Common Stock 6.881 6.881 6.881 6.881

New Stock 13.200 13.200 13.200 13.200
Retained Earnings 14.470 19.390 24.890 30.950
Total Shareholder Equity 34.551 39.471 44.971 51.031
Total Liabilities & Net Worth 84 94 103 112

*Calculations:
- Cash = (20/365) x operation expenses
(for 06/30/15, bank notes is converted in cash < the bank notes payable in 2015 was
negative)
- Accounts receivable = (75/365) x net sales (exh.5)
- Inventories = COGS/ 4 (exh.4)
- Net prop & equip = Net sales /4 (exh.4)
- Prepaid expenses = 0.012 x COGS (exh.4)
- Other long-term assets = 0.045 x net sales (exh.4)
- Accounts payable = (30/365) x COGS (exh.4)
- No loan
- accrued expenses = 0.0166 x net sales (exh.4)
- Common stock unchanged
- Retained Earning = RE last year + NI this year
- Operating expenses = average of previous 4 years
- Debt = bank notes payable + Current portion of long-term debt + long-term debt
6/30/2012 6/30/2013 6/30/2014 6/30/2015
Equity Multiplier 2.43 2.38 2.29 2.20
Total Debt (Millions) 42.61 46.28 49.02 51.08
Debt as % of Total Assets 51% 49% 48% 46%
Debt as % of Owners Equity 123% 117% 109% 100%

6
 Advanced Accounting 56 Fin300 report Group 3

Pacific Grove Spice Company Income Statement after acquiring High Country Seasonings
Income Statement 06/30/12 06/30/13 06/30/14 06/30/15
Net Sales $111.874 $125.103 $137.669 $149.180
Cost of Goods Sold 66.010 73.185 80.536 87.270
Gross Profit Margin 45.864 51.918 57.132 61.910
R&D Expense 1.677 2.002 2.203 2.387
SG&A Expense 34.977 39.407 43.366 46.992
Earnings Before Interest & Taxes 9.210 10.509 11.564 12.531
Interest Expense 3.317 3.657 3.926 4.129
Earnings Before Income Taxes 5.892 6.852 7.638 8.403
Income Taxes 1.591 1.850 2.062 2.269
Net Income 4.301 5.002 5.576 6.134

We suggest that Pacific should acquire High Country Seasonings as

Acquiring High Country Seasonings could help Pacific Grove grow stronger in the
industry and own more market share.
High Country Seasonings has a better debt structure than Pacific, which could help
Pacific Grove improve its financial statements to achieve the banks requirements
quickly.
Pacific Grove could learn some advantages from High Country Seasonings to
reduce costs.
Acquiring High Country Seasonings would show a positive attitude to the
shareholders and the market, the stock price may increase.

7
 Advanced Accounting 56 Fin300 report Group 3

CONCLUSION

1, Should Pacific accept an offer from a cable cooking network to produce and sponsor a
new program? This opportunity would increase the companys sales, profits, and cash flow
above the presented in Exhibit 1, but would require investment in television equipment,
capacity and working capital

If the company really wanted to move forward with this option even though we do not think
it is a good idea, they could gain capital and not increase debt by selling shares of the
company. However, current shareholders may not like this option.

2, Should Pacific raise new equity capital by selling shares of common stock?

Selling shares of common stock have more advantages and fit with requirement of the bank
then Pacific should sell shares of common stock to raise new equity capital.

3, Should Pacific acquire High Country Seasonings?

Yes, they should acquire High Country Seasonings as long as the purchase price would not
be greater than the companys estimated value.