CPA Mock Evaluation

Performance Management Elective

Page 1

ELECTIVE (PERFORMANCE MANAGEMENT): Elective examinations will be 3 hours in length. Candidates will be given 4 hours to complete the examination, providing an extra hour to formulate their responses. The intention is to reduce the time constraint. The Elective examinations will be made up of a mix of objective-format questions and cases. The split and length may vary somewhat across the Electives to adapt to learning outcomes required. Elective examinations use larger and more complex cases than those used for Core 1 and Core 2, requiring a minimum of 60 and a maximum of 120 minutes to complete. The assessment of professional skill will continue in a multi-competency environment, always building on prior learnings, however, greater than 50% of assessment opportunities will be related to the Elective area being examined. Elective cases require candidates to simulate the “roles” they will play in real life, and therefore access will be provided to the reference tools they would use, where practical to do so. Below is an example of a longer case that is focused on the Performance Management competencies, drawing heavily on Core Finance competencies. ROMACORRAL FOODS LTD. Suggested Time: 120 minutes (represents the time judged necessary to complete the question)

Overview RomaCorral Foods Ltd. (RCFL) is a Canadian public company listed on the Toronto Stock Exchange (TSX) but controlled by its parent company – Entertainment, Food, and Leisure PLC (EFL), a British public company listed on the London Stock Exchange (LSE). The parent company reports under International Financial Reporting Standards (IFRS). RCFL owns and operates two chains of restaurants in Canada. One chain specializes in Italian cuisine (Roma Italian) and the other in mid-level steak house cuisine (Corral Steak House). History Parent Company – Entertainment, Food, and Leisure PLC (EFL) EFL is one of the largest companies in the hospitality business worldwide. The company’s European operations include a few hotel chains, several restaurant chains, and a chain of coffee shops. In Canada, EFL owns 75% of the common shares and all of the preferred shares of RCFL. RomaCorral Foods Ltd. (RCFL) RCFL operates under the following mission statement:
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CPA Mock Evaluation

Performance Management Elective

Page 2

RomaCorral Foods Ltd. provides Canadian consumers with excellent food and refreshments at good value and in comfortable, relaxing surroundings while providing its investors with aboveaverage returns through operational efficiency and selective, aggressive growth. In addition, RCFL adopted the following vision statement: RomaCorral restaurants are the preferred choice of North American consumers seeking highquality food and refreshments at affordable prices. As of June 30, 2014, there were 70 Roma Italian (Roma) restaurants and 24 Corral Steak Houses (Corral) restaurants in mid- to large-sized cities throughout Canada.

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CPA Mock Evaluation

Performance Management Elective

Page 3

In late 2014, Raymonde Plante became CEO of RCFL. Plante felt it would be wise to revisit RCFL’s operating strategies and, together with the board of directors, developed a high-level environmental scan (see Appendix 1). The Canadian Food Service Industry The food service industry is a large, dynamic, and innovative sector of the Canadian economy. The main segments in the food service industry and their market shares (shown as percentages) are as follows: 1. Full-service restaurants (35%) – Licensed and unlicensed fine-dining, mid-level, casual, and family restaurants as well as restaurant/bar combinations. 2. Limited service restaurants (34%) – Quick-service (fast-food) restaurants, coffee shops, cafeterias, food courts, and takeout and delivery outlets. 3. Social and contract caterers (6%) – Caterers supplying food services to institutions, airlines, railways, recreational facilities, and special events. 4. Other food service providers (25%) – Bars, hotels, motels, resorts, hospitals, schools, prisons and other institutions, department store cafeterias, vending machines, stadiums, movie theatres, street vendors, private clubs, seasonal entertainment operations, etc. The following are considered the main reasons for a restaurant’s success: appropriate location and offerings for the target market, consistent quality of food and service, and effective capitalization. Supply chain management is essential to ensure high-quality food while controlling costs. Scheduling is another important factor in cost control, given that labour must correspond to demand. Individual restaurants have a wide range of operating results, as shown in the following table: Restaurant Financial Data as a Percentage of Sales – Industry Ranges Food, beverages, and other direct materials Wages and benefits Operating expenses Occupancy expenses (rent, insurance, utilities, etc.) General and administrative expenses Income (loss) before interest, amortization, and taxes 25% to 40% 25% to 40% 7% to 13% 4% to 14% 1% to 5% (1.5%) to 19%

Average net profit margin in the Canadian food service industry slowly improved from a low of 3.2% in 2007 to 4.5% in 2010 before declining to 4.3% in 2011.

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CPA Mock Evaluation RCFL Operations

Performance Management Elective

Page 4

The organizational chart of the management team is contained in Appendix 2. Restaurant Operations – General Most of the Roma and all of the Corral restaurants are located near, or within, suburban shopping areas in mid- to large-sized Canadian cities. Most RCFL restaurants are served by public transportation and have sufficient no-charge parking nearby. RCFL restaurants are open six days per week for both lunch and dinner and on Sundays for dinner only. As is typical of full-service restaurants, RCFL outlets tend to be quiet on Mondays and become busier as the week progresses, with Sunday business being somewhat unpredictable. Each restaurant has a manager who is responsible for his/her restaurant’s operation. The RCFL head office is responsible for implementing and maintaining information and accounting systems, developing the corporate-wide supply chain, providing training support as needed, processing payroll, building new outlets, evaluating manager and restaurant performance, facilitating major repairs or renovations, maintaining insurance, developing chain-wide advertising and promotions, conducting internal audits, arranging for external audits, and managing corporate banking. Head office is also responsible for setting menus and prices. Both Roma and Corral outlets are considered busy restaurants. Most outlets operate at about 80% of their practical maximum capacity which is considered good in the industry. For purposes of evaluating the performance of the individual outlets in each chain, a benchmark is set at the average monthly sales per seat achieved by the restaurant with the highest annual sales in that division. Each outlet is expected to achieve at least 85% of this benchmark, as well as a target net profit margin set by head office each year. Compensation and Staffing At the restaurant level, RCFL pays competitive wages for managers, assistant managers, and kitchen workers and slightly more than minimum wage for bartenders, servers, and hosts/hostesses. Annual management bonuses for each restaurant are based on achieving the target average monthly sales per seat (i.e. at least 85% of the benchmark) and the target net profit margin. It is not difficult to hire staff for RCFL restaurants, but many of the better servers leave after a few years. This is puzzling because their restaurants are among the busiest in the industry, and servers’ tips tend to be higher at RCFL outlets than at most other restaurants.

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CPA Mock Evaluation Banking

Performance Management Elective

Page 5

RCFL has used the Capital Bank of Canada (CBC) and they have built a good working relationship. CBC provides RCFL with 75% mortgage financing on each land and building purchase for a new restaurant, as well as a line of credit to a maximum of 50% of the total of accounts receivable and inventory. The line of credit is offered at the prime rate, and the mortgages at 0.5% below the bank’s basic long-term mortgage interest rate. As a company listed on the TSX, RCFL must submit annual, audited financial statements. (See Appendix 3) Current Situation As a result of the economic recession that began at the end of 2014, Canadian consumers continued to reduce discretionary spending in the first six months of 2015. Sales at Canadian restaurants fell, and experts predict that 2016 revenues will drop by 2.5%. Sales at full-service restaurants are expected to show the largest decline (3%) as cost-conscious consumers switch to limited-service restaurants, where sales are expected to decline less severely (1.5%). Many full-service restaurants with prime costs (direct materials and labour) greater than 65% of sales recorded losses in the first half of 2015. Some steak houses in Canada, which generally have higher prime costs than Italian restaurants, went out of business. In contrast, sales at coffee shop chains, which have higher prime costs (68%-72%) increased in the first half of 2015 and are predicted to remain relatively strong, resulting in an average increase in sales of 2% per year over the next two years. In fiscal 2015, RomaCorral Foods Ltd. (RCFL) experienced a 1.5% decrease in average annual sales per restaurant but an increase in overall sales as a result of opening six new restaurants. Overall profits increased, and RCFL paid a dividend of $2 per share on both the common and preferred shares. The EFL board of directors reduced its expectations for RCFL’s growth in net income after taxes. Instead of a growth rate of 20% per year, the board indicated it required RCFL to achieve an after-tax net profit growth rate target of 5% over the next two years (i.e. net income of $42,901,583 in fiscal 2017) and to pay a dividend of $2 per share annually on both common and preferred shares. The board also indicated that EFL would not be able to provide RCFL with any financing for at least the next three years. Senior Staff Meeting – July 2015 Plante assembled the senior staff to discuss possible Roma expansion onto the parcels of land that RCFL has options on.

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CPA Mock Evaluation

Performance Management Elective

Page 6

Singh informed the group that RCFL currently holds options on parcels of land in locations that would be very suitable for opening 7 Roma outlets. Each option, which cost $50,000 at the end of 2013 (shown separately on the statement of financial position), gives RCFL the right to purchase the designated parcel of land for an additional $550,000 before January 1, 2016, at which time the options will lapse. The 2015 average income per restaurant in operation for more than one year and the performance targets for each division are highlighted in Appendix 4. During 2015, all restaurants met the sales target and most met the net profit margin target. Plante indicated that he expects the economy to stabilize soon and that the average sales per restaurant will remain at the fiscal 2015 levels in the foreseeable future. He also indicated that January 1, 2016, is the earliest any new restaurant could be ready to open. He expressed his concern in opening new restaurants without EFL’s financial support and provided the following summary of the required capital investments for each new restaurant: Roma Outlet $ 600,000 $ 4,500,000 $ 1,000,000

Land (including cost of option) Building Furniture and equipment

The seven locations for proposed Roma outlets would not be suitable for steak houses. Initial promotional campaigns for the new Roma restaurants would cost approximately $50,000 per outlet. 1. In addition to providing RCFL with 75% mortgage financing for new land and buildings, CBC is willing to refinance the existing mortgages (without a penalty) for up to 75% of the fair value of the land and buildings of existing restaurants, provided that the ratio of long-term debt (including the current portion) to equity does not exceed 2 to 1. As of June 30, 2015, the net fair value of RCFL’s land and buildings was approximately $405 million. The bank will charge RCFL 4% annual interest on its line of credit and issue new or refinanced mortgages (5-year term, amortized over 25 years) at 3.5%. 2. RCFL uses a discount rate of 10% after taxes and a 20-year time horizon for evaluating investments in restaurants. Land values are expected to double in 20 years and the fair values of other assets are expected to equal their book values. Required: As Alicia King, CPA, analyze the current situation of RomaCorral Foods Ltd., update the environmental scan, analyze the expansion alternative facing RCFL, and prepare a report for the senior management team advising them on the strategies to follow in order to meet the targets imposed by the parent company, EFL.

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CPA Mock Evaluation

Performance Management Elective

Page 7

APPENDIX 1 ROMACORRAL FOODS LTD. ENVIRONMENTAL SCAN – DECEMBER 2014 Strengths  Experience and expertise of parent company and management  Good reputation for quality food at reasonable prices  Growth of brand  Consistency in outlet appearance and menu pricing throughout Canada  Good locations close to target markets  Adequate parking and easy accessibility via public transit  Reliable supply chain that delivers goodquality food  Preferred client status with bank  Good base of long-term customers Opportunities  Increasing consumer spending in Canadian food service industry  Shifting demand from fine-dining restaurants to mid-level and fast-food restaurants  Expected decrease in some food prices (produce, beef, veal) over next nine years Weaknesses  Inconsistencies in customer service among restaurants  High turnover of the better servers  High debt load  Room for improvement in production volume (as a percentage of practical maximum capacity)  Recent reduction in sales per outlet

Threats  High competition in all food service markets  High staff turnover in food service industry  Economic downturn  High price of wheat

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CPA Mock Evaluation APPENDIX 2

Performance Management Elective

Page 8

ROMACORRAL FOODS LTD. ORGANIZATIONAL CHART As at June 30, 2015 Board of Directors Anthony Pickens – Chair Mélanie Boucher James Finney – Audit committee Beryl Sayad Edgar Fortune – EFL representative Raymonde Plante Connie Buckner President and CEO Raymonde Plante

Vice-President, Head Office Operations Connie Buckner

Vice-President, Development Prosad Singh

Vice-President, Roma Division Josh Belli

Vice-President, Corral Division Jackie Browne

Controller Alicia King

Manager, Property Development

Restaurant Managers

Restaurant Managers

Information Technology Ben Tang

Manager, Marketing

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CPA Mock Evaluation APPENDIX 3

Performance Management Elective

Page 9

ROMACORRAL FOODS LTD. CONSOLIDATED STATEMENT OF FINANCIAL POSITION As at June 30 (in thousands of dollars) 2015 (draft) $ 3,027 3,095 14,487 680 699 21,988 2014 (audited) $ 2,692 2,778 12,479 630 429 19,008 2013 (audited) $ 2,692 2,778 12,479 630 429 19,008

Assets Current Assets: Cash Accounts recivable Inventory Land options Other Non-current Assets: Land Buildings Less: Accumulated depreciation Furniture and equipment Less: Accumulated depreciation

Total Assets Liabilities and Shareholders’ Equity Current Liabilities: Bank line of credit Accounts payable and accrued liabilities Current portion of long-term debt Due to parent Long-term Liabilities: Deferred taxes Mortgage payable (net of current portion) Total Liabilities Shareholders’ Equity: Common shares Preferred shares Revaluation surplus Retained earnings Total Liabilities and Shareholders’ Equity

60,290 368,320 30,395 337,925 111,346 38,164 73,182 471,397 $493,385

68,690 337,770 21,586 316,184 103,346 27,430 75,916 460,790 $479,798

43,690 334,780 21,586 313,194 103,346 27,430 75,916 432,800 $451,808

$

2,100 19,662 8,562 4,000 34,324 9,182 274,579 318,085

$

1,600 19,379 6,904 21,000 48,883 12,712 258,616 320,211

$

1,600 19,379 6,904 21,000 48,883 1,512 258,616 309,011

70,000 10,000 7,800 87,500 175,300 $493,385

70,000 10,000 15,000 64,587 159,587 $479,798

70,000 10,000 – 62,797 142,797 $451,808

As at June 30, 2015, there were 7 million common shares and 1 million preferred shares outstanding.

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CPA Mock Evaluation APPENDIX 3 (continued)

Performance Management Elective

Page 10

ROMACORRAL FOODS LTD. CONSOLIDATED STATEMENT OF CONPREHENSIVE INCOME For the years ended June 30 (in thousands of dollars) 20 20 20 15 14 13 $340,095 $308,675 $308,675 103,475 95,390 8,559 207,424 132,671 13,618 6,461 11,115 17,129 (50) 8,808 10,735 67,816 64,855 25,942 38,913 93,825 87,098 7,534 188,457 120,218 12,107 6,040 10,356 14,641 (30) 7,622 9,565 60,301 59,917 23,971 35,946 93,825 87,098 7,534 188,457 120,218 12,107 6,040 10,356 17,631 (30) 7,622 9,565 63,291 56,927 22,771 34,156

Sales Variable restaurant costs: Food and beverages Salaries, wages and benefits Other variable costs Contribution margin Expenses: Facilities (excluding amortization) Selling, advertising and promotion General and administration Interest Change in fair value of options Depreciation – buildings Depreciation – furniture and equipment

Income before taxes Income taxes (40%) Net income Other comprehensive income item Change in revaluation surplus net of tax (7,200) (3,000) – Comprehensive Income $ 31,713 $ 32,946 $ 34,156 Supplemental Schedule – Reconciliation of Retained Earnings Opening retained earnings $ 64,587 $ 40,641 $ 40,641 Net income 38,913 35,946 34,156 Dividends (16,000) (12,000) (12,000) Closing Retained Earnings $ 87,500 $ 64,587 $ 62,797

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CPA Mock Evaluation APPENDIX 3 (continued)

Performance Management Elective

Page 11

ROMACORRAL FOODS LTD. RATIO AND PERFORMANCE ANALYSIS Ratios Current ratio (liquidity) Quick ratio (liquidity) LT debt-to-equity (coverage) Total debt-to-equity (coverage) Total debt-to-total assets (coverage) Times Interest Earned (coverage) Inventory turnover (activity) Asset turnover (activity) Net margin or return on sales (profitability) EPS (profitability) Contribution margin % (profitability) Return on equity (ROE) (profitability) Return on assets (ROA) (profitability) Revenue growth 2015 0.64 0.18 2014 0.39 0.11 2013 0.39 0.11

1.62 1.66 1.86 1.81 2.01 2.16 0.64 0.67 0.68 4.79 5.09 4.23 7.14 times 7.52 times 7.52 times (51.12 days) (48.54 days) (48.54 days) 0.69 0.64 0.68 11.44% 11.65% 11.07% $5.27 39.00% 22.20% 7.89% 10.18% $4.92 38.95% 22.52% 7.49% $4.67 38.95% 23.92% 7.56% 23.44%

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CPA Mock Evaluation
APPENDIX 4

Performance Management Elective

Page 12

ROMACORRAL FOODS LTD. SELECTED FINANCIAL DATA FOR A ROMA RESTAURANT For the year ended June 30, 2015 (in thousands of dollars-except target average monthly sales per seat) Roma1 3,197 902 869 8 5 1,85 6 1,34 1 140 21 54 81 98 291 68 5 656 26 2 394 200 1,231 12%

Sales Food and beverages Salaries, wages and benefits Other variable costs Total variable costs Contribution margin Facilities (excluding amortization) Selling, local advertising and promotion General and administration Depreciation – building Depreciation – furniture and equipment Head office allocation2

$

Income before taxes Income taxes (40%) Net income Number of seats Target average monthly sales per seat3 Target net profit margin
1

$ $

2

3

Amounts represent the average sales and expenses for restaurants that have been operating for more than one year. Head office costs (including regional office costs) are allocated evenly to the individual outlets. Total head office costs were $27,456,000 in fiscal 2014 and $29,071,000 in fiscal 2015. These costs are expected to be $31,200,000 in fiscal 2016 and $32,600,000 in fiscal 2017. The target average monthly sales per seat for performance evaluation purposes is set at 85% of the benchmark. The benchmark is set at the average sales per seat achieved by the restaurant with the highest annual sales in that division.

CPA Mock Evaluation MARKING GUIDE ROMACORRAL FOODS LTD.

Performance Management Elective

Page 13

This case focuses on candidates’ ability to analyze a situation and then to analyze the strategic options presented and suggest a course of action that is consistent with their analysis. This particular case also draws heavily on candidates Core Finance skills for their quantitative analysis. Candidates are expected to use their judgment in assessing which issues are the most relevant and to what extent these issues should be analyzed. SITUATIONAL ANALYSIS Assessment Opportunity #1 The candidate performs a detailed environmental analysis. CPA Mapping 2.3.1 Evaluates the entity’s strategic objectives and related performance measures 2.3.2 Evaluates the entity’s internal and external environment and its impact on strategy development Core B B PM-Elective A A

The following tables list the points candidates are expected to present. Mission: RomaCorral Foods Ltd. provides Canadian consumers with excellent food and refreshments at good value and in comfortable, relaxing surroundings while providing its investors with above-average returns through operational efficiency and selective aggressive growth. RomaCorral restaurants are the preferred choice of North American consumers seeking high-quality food and refreshments at affordable prices. Achieve an after-tax net income growth rate target of 5% over the next two years (i.e. net income of $42,901,583 in fiscal 2017). Pay a dividend of $2 per share annually. Obtain an average return on investment of 10%.

Vision:

Strategic Goals:

Stakeholders’ Preferences: Singh Plante

Indicated that options on parcels of land that would be suitable for opening Roma outlets. Questioned the feasibility of opening new restaurants without any financing from EFL.

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CPA Mock Evaluation Key success factors

Performance Management Elective Location Menu Food and service quality Capitalization Supply chain management Scheduling of labour

Page 14

Constraints

The bank is willing to refinance the existing mortgages for up to 75% of fair value of land and buildings of existing restaurants, provided that the ratio of long-term debt to equity does not exceed 2 to 1.

Environmental Scan/SWOT Analysis: The following are some additional SWOT points that candidates may provide in their responses. Strengths  Overall profits increased for RCFL and all restaurants met the sales target and most met the net profit margin target.  RCFL holds options on 12 parcels of land.  Bank will refinance the existing mortgages for up to 75% of the fair value of the land and buildings.  Many full-service restaurants with prime costs (direct materials and labour) greater than 65% of sales recorded losses. RCFL prime costs are less than 65%. Opportunities  Plante indicated that she expects the economy to stabilize soon. Weaknesses  EFL would not be able to provide financing for three years.  Head office costs are allocated evenly to the individual outlets.  RCFL experienced a 1.5% decrease in average annual sales per restaurant.  Annual management bonuses are based on achieving the target average sales per seat and the target net profit margin; weakness is that there are no qualitative measures for performance evaluation.  RCFL outlets tend to be quiet on Mondays Threats  Restaurant revenues will drop by 2.5% in 2016.  Sales at full-service restaurants are expected to show the largest decline (3%).  Cost conscious consumers are expected to switch to limited-service restaurants.  Sales at limited-service restaurants are only expected to decline 1.5%.

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CPA Mock Evaluation Situational Analysis Point Mission/Vision Goals Stakeholder Needs/Preferences Constraint KSFs Strengths Weaknesses

Performance Management Elective

Page 15

Opportunities Threats

Description Consistent with the mission/vision? Meets goals? Stating if an alternative does or does not meet a specific stakeholder’s need or preference. E.g. Calculating the debt: equity and comparing it to the bank’s constraint of 2:1. In order to link to a KSF, it must be valid and considered in the analyses of the alternatives. Option/issue strengthens or uses a strength. Option/issue must: 1. address how the alternative/ action will solve the weakness, or 2. use the weakness for justification of not doing something, or 3. discuss how the alternative/option will worsen an existing weakness. Must indicate how alternative/option takes advantage of the opportunity. Must use the threat as a justification for not doing something or must indicate how the option/action would address a threat.

Financial Assessment: Assessment Opportunity #2 The candidate performs a financial analysis of the company (part of environmental scan). Also draws on Core competencies in Finance: 5.1.1 Evaluates the entity’s financial state (i.e. ratio analysis, benchmarking, etc.)

B

NA

The following are some points that may be made in discussing the current financial situation of the company (either in the SWOT analysis or in a separate financial assessment section or in the analysis of the issues). Ratio Analysis:  Liquidity is low (although not completely unexpected given that the majority of restaurant sales would be cash/credit card leaving the receivables lower than in a traditional business which impacts the current assets).  Coverage appears to be adequate, below the bank’s benchmark of 2:1.  Inventory turnover has been declining which is a concern in the restaurant industry where good-quality food is of importance.  Accounts receivable turnover is low, staying steady at just over 3.32 days which is expected due to the cash nature of the business.  Revenues are growing, and profitability ratios remain steady.
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CPA Mock Evaluation Benchmarks – See Appendix 1:

Performance Management Elective

Page 16

 Food and beverage cost of sales, restaurant salaries, wages and benefits, facilities expenses, general and administrative expenses and operating expenses are all well in line with the industry benchmarks.  Income before interest, depreciation and tax, and net margin are both well above the industry benchmarks.  Prime costs are lower than the benchmark.  Net income and revenue growth both exceed the benchmarks. Overall, RCFL appears very efficient operationally as compared to industry benchmarks and is growing faster and more profitably than its peers. Analysis of Strategic Alternatives Assessment Opportunity #3 The candidate assesses the strategic alternatives. CPA Mapping Core 2.3.3 Evaluates strategic alternatives B Also draws on Core knowledge in Finance: 3.5.1 Performs sensitivity analysis A 5.1.2 Develops or evaluates financial proposals and B financing plans 5.2.3 Evaluates sources of financing B 5.2.5 Evaluates the entity’s cost of capital B Net income shortfall calculation – See Appendix 1  RCFL will need to overcome a $6,106K shortfall to meet its goal of $42,902K net income in 2017. The following are some relevant decision analysis concepts and tools that could be applied in the quantitative analyses of the strategic alternatives: Cost and revenue analysis Relevant revenues, costs, contribution margins, opportunity costs, cash flows, break even, and/or net income are appropriately calculated and interpreted for the alternatives or for the recommended strategy. Assumptions are clearly indicated and are reasonable. Elective A N/A N/A N/A N/A

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CPA Mock Evaluation After-tax net income for 2016

Performance Management Elective

Page 17

The incremental or total after-tax net income is calculated for the alternatives or for the recommended strategy and compared to the target (i.e. $41,863,800 for RCFL overall). The increase in head office costs is included in the calculation of the required incremental income for 2016 or in the calculation of total 2016 net income for each alternative or for the recommended strategy. Capital budgeting / discounted cash flow analysis Appropriate capital budgeting or discounted cash flow analysis methods (e.g. net present value, internal rate of return, capital rationing) are applied correctly in analyzing the alternatives. For example, the following are included in the analysis: (i) appropriate operating cash inflows and outflows for each year, capital costs and other onetime cash flows (non-cash items and interest are not included); (ii) consideration of the time value of money using the 10% after-tax rate over 20 years; (iii) after-tax cash flows; and (iv) calculation of CCA tax shields on capital cost using a reasonable CCA rate (e.g. 4% for buildings and 20% for furniture and equipment). Note that candidates’ quantitative analyses may be very different, given the different assumptions they will make in preparing them (e.g. assumptions regarding prices, sales volumes, etc.). Their assumptions should be clearly stated and generally consistent with the case information. Other Quantitative Issues Other quantitative tools are applied appropriately in the response, such as the following: Financing required and available The financing required for the strategic alternatives and dividends ($16M) and the financing available [e.g. remortgage current properties (75% x current value – current mortgage outstanding), mortgage of new properties (75% x building and land costs for new outlets), line of credit (50% of accounts receivable and inventory), cash flows generated from future operations] are calculated and compared for each alternative and/or for the recommended strategy. Financial forecast A financial forecast for one or more years that incorporates the expected effects of the major recommendations is prepared. This can be in the form of a pro forma income or cash flow statement, or a pro forma balance sheet.

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CPA Mock Evaluation

Performance Management Elective

Page 18

Recommendations and Conclusions Assessment Opportunity #4 The candidate recommends an appropriate course of action (consistent with analysis). 2.2.1 Assesses whether management decisions align with the entity’s mission, vision, and values 2.4.1 Analyzes the key operational issues and alignment with strategy B B A A

For this case, support should include quantitative analysis that proves that the recommended actions would provide the following (i.e. integration of the constraints and goals, etc): 1. EFL’s target of a 5% growth in after-tax net income over the next two years (i.e. $42,901,583 in fiscal 2017) will be met. 2. The bank’s constraint that the long-term debt (including the current portion) to equity ratio does not exceed 2 to 1 will be met. 3. RCFL will be able to acquire the financing required to implement the recommended strategy. 4. A 10% after-tax rate of return over 20 years will be achieved for the recommended capital investments. 5. Sufficient cash flows will be generated to enable an annual dividend payout of $2 per share (i.e. $16 million). Sample Analysis The following appendices provide sample analyses to assist the markers in recognizing valid points and calculations made by candidates.

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CPA Mock Evaluation APPENDIX 1 FINANCIAL ASSESSMENT Figure 1: Benchmarks

Performance Management Elective

Page 19

Food and beverage % of sales

Restaurant salaries, wages and benefits % of sales

Facilities % of sales General and administration % of sales Operating expenses % of sales

Formula Food and beverage cost of sales / sales Restaurant salaries, wages and benefits / sales Facilities (excl. amort.) / sales General and admin. / sales Total expenses head office expenses / sales (Income before tax + interest + depreciation) / sales

2015 2014 2013 Benchmark $103,475/ $83,825/ $83,825/ $308,675 25.00%= 27.16% 40.00% $340,095 $308,675 = 30.43% = 27.16% $95,390/ $340,095 = 28.05% $87,098/ $87,098/ $308,675 = 28.22% $308,675 = 28.22% 25.00%40.00%

Income before interest, depreciation and tax % of sales

Prime costs % of sales

(Food and beverage cost of sales + restaurant salaries, wages and benefits) / sales Net margin or return on net income / $38,913/ sales sales $340,095 = 11.44%

$13,618/ $12,107/ $12,107/ $308,675 = 3.92% $340,095 $308,675 = 4.00% = 3.92% $11,115/ $10,356/ $10,356/ $308,675 = 3.35% $340,095 $308,675 = 3.27% = 3.35% ($67,816- ($60,301$29,071)/ 27,456)/ $340,095 = $308,675 = $38,745/ $32,845/ $340,095 $308,675 = 11.39% = 10.64% ($64,855 ($59,917 ($56,927 +$17,631 +$17,129 +$14,641 +$7,622 +$9,565)/ +$8,808 +$7,622 $308,675 = +$10,735)/ +$9,565)/ $91,745/ $308,675 = 29.72% $340,095 = $308,675 = $101,527/ $91,745/ $340,095 $308,675 = 29.85% = 29.72% ($103,475 ($93,825 ($93,825 +$95,390)/ +$87,098)/ +$87,098)/ $340,095 = $308,675 = $308,675 = $198,864/ $180,923/ $180,923/ $308,675 = 58.61% $340,095 $308,675 = 58.47% = 58.61%

4.00%14.00% 1.00%5.00% 7.00%13.00%

(1.50%)19.00%

65.00%

$35,946/ $34,156/ $308,675 3.20-4.50% = 11.07% $308,675 = 11.65%

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CPA Mock Evaluation

Performance Management Elective Formula (net income current year - net income prior year) / (net income prior year) (revenue current year - revenue prior year) / (revenue prior year) 2015 ($38,913$35,946)/ $35,946 = $2,967/ $35,946 = 8.25% ($340,095$308,675)/ $308,675 = $31,420/ $308,675 = 10.18% 2014

Page 20

Net income growth

2013 Benchmark ($34,156- $25,692)/ 20.00% $25,692 = $8,464/ $25,692 = 32.94%

Revenue growth

($308,675$250,067)/ $250,067 = $58,608/$250,067 = 23.44%

(3.00%)

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Page 21

Figure 2: Net Income Shortfall for 2017 Net Income for 2016 – No Expansion: 2015 income before taxes Increase in head office costs1 2016 income before taxes Income taxes (40%) 2016 net income 2015 net income Incremental net income (2016 – 2015) Net Income for 2017 – No Expansion: 2015 income before taxes Increase in head office costs1 2017 income before taxes Income taxes (40%) 2017 net income 2015 net income Incremental net income (2017 – 2015) Target 2017 net income Shortage in 2017 net income (need from expansion)

Formula/Source $31,200-$29,071

Roma $656 21 635 254 $381 394 $(13)

Corral $799 21 778 311 $467 479 $(12)

Total $64,855 2,129 65,726 26,290 $39,436 38,913 $523

$32,600-$29,071

$656 35 621 248 $373 394 $(21)

$799 35 764 306 $458 479 $(21)

A1

$64,855 3,529 61,326 24,530 $36,796 38,913 $(2,117) $42,902

A2 $42,902-$36,796 A3

$6,106

Target 2017 net income 2015 net income

Case Case

A2 A4

$42,902 $38,913

1

Assumes continued equal distribution of head office costs among 100 outlets.
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Page 22

APPENDIX 2 ANALYSIS OF ALTERNATIVE TO EXPAND ROMA QUANTITATIVE ANALYSIS Figure 1: Net Present Value Analysis Formula/ Source

Incremental Cash Flow from Operations (One Outlet): Net income (assume same as 2015) Add back tax Add back depreciation – building Add back depreciation – F&E Add back HO allocation Less tax @ 40% Cash flows (not including increase in HO costs*) PV factor (10%, 20 years) Present value of cash from operations – 1 outlet Roma initial promotion ($50K x (1-0.4) x 0.909) CCA tax shield (Note 1) Less investment for capital assets Net present value 1 outlet NPV Total New Outlets: NPV one outlet Number of outlets Total NPV Note 1: CCA Tax Shield2 per Outlet: Building (4%) Furniture and equipment (20%) Total CCA tax shield per outlet

Roma $ 394 262 81 98 291 B1 1,126 450 676 8.51356 $ 5,755 (27) 746 (6,050) $ 424

B3&B4

B5 B7 B5*B7; B6*B8 B9

$ 424 7 $2,968

$4913 2554 $746

2 3

[(CdT)/(d+k)]*(2+k)/[2*(1+k)] [($4,500*0.04*0.40)/(0.1+0.04)]*(2+0.1)/[2*(1+0.1)] 4 [($1,000*0.2*0.40)/(0.1+0.2)]*(2+0.1)/[2*(1+0.1)]
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Performance Management Elective

Page 23 $405,000 303,750 283,141 $ 20,609 $ 3,095 14,487 17,582 $ 8,791 $(2,100) $ 6,691

Current value of land and buildings Max total mortgages Mortgage owing end of 2015 Max available from bank from remortgaging Note 2: Financing Available from Line of Credit: Accounts Receivable Inventory Total Max available from bank @ 50% Less: current balance Financing available from line of credit Figure 2: Financing Required Financing Required (One Outlet): Land Building Furniture and equipment Total Sunk cost Cash investment required for capital assets Total Financing Required: One outlet Number of outlets Total financing required Financing available: Land Building Base for mortgage 75% mortgage available from bank Cash investment required for one outlet 75% mortgage available from bank Required to be financed from other sources Number of outlets Total required to be financed from other sources

$405,000 x 75% $274,579+$8,562 B17 a b c d e f

a+b c*50% d+e

Formula/ Source

Roma Only $ 600 4,500 1,000 6,100 (50) B3 $6,050

B3&B4 B7&B8

$ 6,050 7 $42,350

B11 B3&B4 B11&B12 B13 B15 B13*B15; B14*B16 B17 f

$ 600 4,500 $5,100 $3,825 $ 6,050 (3,825) 2,225 7 $15,575 $20,609 6,691 $11,725

Total financing available from remortgaging (Note 1) Total financing available from line of credit (Note 2) Surplus (shortage) Note 1: Financing Available from Remortgaging Existing Outlets:

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Page 24

Figure 3: Impact on Net Income Net Income for 2016: Cash flow from operations before tax – 1 outlet Depreciation – building (Note 1) Depreciation – F&E (Note 1) Income before tax and HO allocation Number of outlets Total income before taxes from new outlets Income taxes (40%) Net income from new outlets 2017 Target Net Income Shortage Surplus (shortage) Alternative Calculation: Total income before taxes from new outlets Incremental head office costs Incremental income before taxes Income taxes (40%) Incremental net income 2015 net income Estimated net income for 2017 Target 2017 net income Surplus (shortage) Note 1 – Depreciation per New Outlet: Building Useful life (years) Amortization per year per outlet straight line Number of outlets Total incremental amortization – building Furniture and equipment Useful life (years) Amortization per year per outlet straight line Number of outlets Total incremental amortization – building Figure 4: Impact on Debt: Equity Formula/ Source B1&B2 c&d j&k Roma $1,126 112.5 100 913.5 7 6,395 2,558 $3,837 $ 6,106 ($2,269)

B18 B21 A3 B21-A3; B22-A3; B23-A3

B18 A1

B24 A4 B24+A4; B25+A4; B26+A4 A2 B27-A2; B28-A2; B29-A2 B27

$ 6,395 3,529 2,866 1,146 1,720 38,913 $40,633 42,902 ($2,269)

a÷b c*e; d*e

a b c e f h i j l m

$4,500 40 112.5 7 $787.5 $1,000 10 100 7 $700.0

h÷i j*l; k*l

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Page 25

Financing Required: Cash investment required for capital assets per outlet Number of outlets Total financing required Financing available: 75% mortgage available from bank Number of outlets Mortgage financing Required to be financed from other sources Current equity as at June 30, 2015 Current long-term debt as at June 30, 2015 (includes current portion) Additional debt New long-term debt New debt: equity

Formula/ Source B3 B7&B8 B3*B7; B4*B8 B11&B12 B7&B8 B11*B7; B12*B8 B30-B32; B31-B33

Roma $ 6,050 7 $42,350 $ 3,825 7

B30

B32 B34 B36 B37

$26,775 $15,575 $175,300 $283,141 $ 15,575 $298,716 1.70:1

B34&B35 B34+B37; B35+B37 B38÷B36; B39÷B36

B38

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Performance Management Elective

Page 26

Pros  This would let RCFL exercise its options on 12 parcels of land in suitable locations (S).  This would let RCFL spread its growing head office overhead over more locations (W).  Has a positive net present value over the next twenty years (see Appendix 2, Figure 1) – the expected NPV is $5,988K.  Additional net profit exceeds net income goal by $872K (see Appendix 2, Figure 3) (G).  1.70:1 D:E would not exceed requirement from the bank (Appendix 2, Figure 4) (C).  RCFL has strength in experience and expertise in management and operation of Roma and Corral outlets (S).  Expanding outlets would build upon a recognized strength for a good reputation for quality food at reasonable prices (S/KSF/M).  Expansion could also take advantage of increasing consumer away from fine-dining (O).

Cons  High wheat prices increase the cost of pasta, which squeezes margins at Roma outlets (T – for Roma).  Sales at full-service restaurants are expected to show the largest decline (3%) which would impact success (T).  There is a continuing threat of high competition in all food service markets, which is exacerbated by the overall decrease in sales at Canadian restaurants in first half of 2015 and forecast decline in sales at full-service restaurants (T).  RCFL would not be able to immediately undertake a full expansion (12 stores), owing to financing constraints (see Appendix 2, Figure 2).

M: Mission C: Constraint W: Weakness A1: Alternative 1 SP: Stakeholder’s preference APPENDIX 3 DIVIDEND CONSIDERATIONS

V: Vision K: Key success factor O: Opportunity A2: Alternative 2

G: Goals S: Strength T: Threat TG: Target

Candidates should also consider the payment of the dividend in their recommended strategy. A basic calculation showing the cash flow/income generated and comparing it to the $16M dividend required is sufficient. If pro forma statements are prepared, this dividend payment may/should also be reflected here for reference.

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