Palompon Institute of Technology

6538 Evangelista Street, Palompon, Leyte

College of Technology and Engineering
Mechanical Engineering Department

GE 5:
ENGINEERING MANAGEMENT
(Case Study Samples on Engineering Management)

Submitted by:
JOHN RYAN A. TOLEDO
Student

Submitted to:
ENGR. ROMIL L. ASOQUE
Instructor
 Improving Production At Beothic Fish
Processors Ltd.

"The Pelagic processing area at the plant in Valleyfield, Newfoundland, has not worked out as well as
we had hoped for processing capelin," identified the General Manager of Beothic Fish Processors Ltd.
"Although the company continues to be very successful, if we are to offer competitive prices and still
earn a profit we must keep our production costs as low as possible, and given that production costs
are a function of production efficiency, it is imperative that we improve our present production
system. It appears to me that we must look carefully at our existing plant layout to accomplish this."

Company Background

Beothic Fish Processors Ltd. (Beothic) was one of the largest processors of pelagic (capelin, mackerel
and herring) fish species in Newfoundland and Labrador, with capelin being, by far, the primary
species. Although the company began in 1967, it was not until 1979, when a modern cold storage
facility was constructed at Valleyfield, and new blast freezers were installed, that the company was
able to handle capelin. By 1989, capelin was a major contributor to Beothic's overall profitability.

By Newfoundland standards, capelin processing was a relatively new fishery, having been developed
about thirty years ago. Originally, capelin were sorted by hand, however, it proved impossible to
handle the enormous quantities demanded by the

This case was adapted from a case prepared by Professors Wayne King and Donna Stapleton as a basis for classroom discussion, and is
not meant to illustrate either effective or ineffective management.

Copyright � 1993, the Atlantic Entrepreneurial Institute. Reproduction of this case is allowed without permission for educational
purposes, but all such reproduction must acknowledge the copyright. This permission does not include publication.

market in this manner. The industry soon turned to the use of mechanical sorters which, although not
perfect, were able to process large quantities quickly and at relatively low cost.
The Present Production System

The capelin processing facilities at Beothic are illustrated in Exhibit 1. Capelin entered the system via
a water-filled infeed hopper, labelled as 1 on the exhibit. At this point, the insulated containers used
for transport were simply emptied into the hopper. They then proceeded along a conveyor belt to the
mechanical separator -- a Petco 3500 (2). The separator consisted of a series of ribbed slots, which
gradually increased in size, that the capelin were shaken across. The very small capelin fell out first,
and were conveyed back to the offal area where the unusable portion of the raw material was
collected (3). The intermediate sized capelin, which were the marketable females, fell through next,
and were conveyed to the distribution tables (4). The capelin, which were primarily male, proceeded
to the end of the separator and joined the small females on the conveyor as offal. At each distribution
table, which was actually a conveyor, approximately 18 workers removed by hand and discarded any
unsuitable product that was not eliminated mechanically. At the end of each table (5), the capelin fell
into boxes, which were hand-carried to the weighing stations (6). At this point, the boxes were
checked to ensure that predetermined weights were contained in each. Boxes were then placed on a
metal roller conveyor where they were closed and strapped. They were then placed on pallets, brought
by forklift to the blast freezing area, and frozen to a temperature of -21oC, a process that normally
took 12 to 16 hours. Pelagic species such as capelin were generally blast frozen unless these freezers
were already filled to capacity.

As a variation on the blast freezing system, which would normally only occur when the blast freezers
were completely full, plate freezing may be used. The capelin falling off the distribution tables (5)
were caught in plastic pans, which were carried by hand to the weighing stations (6). After weighing,
the pans were hand-carried to the packing tables (7), where they were emptied into cartons designed
for plate freezing. Because in the plate freezing process the plates exerted pressure on the product,
these cartons had to be placed in metal pans, which helped them retain their shape. The capelin were
then transported by forklift to the main plant area for plate freezing. The metal pans were then
manually removed from each frozen carton of product (the "knocking out process"), and the product
stacked on pallets for cold storage. The additional handling required by this type of freezing increased
unit labour costs and could potentially damage the product, thus making it relatively unattractive to
the processor.
Problems of the Present System

Shortly after preparing this description of his capelin processing facility, the General Manager held a
planning meeting with the plant manager and three production supervisors. The purpose of the
meeting was to review the pelagic production plan for the upcoming year, particularly with respect to
capelin.

"As you probably know," he began, "the single most profitable species processed here at the plant is
capelin. Because the season is so short, only three weeks at best, it is vital that production be
maximized in that period. We have three blast freezers and several plate freezers. It is absolutely vital
that these freezers be kept full. Too often last year, we were not at capacity during this period. I'd like
to take each aspect of our capelin processing system and examine it for problems."

When the meeting had ended, the following list of problem areas were identified by the management
group:

1. Space: All of the group agreed that the production area was extremely crowded with, as one
of the supervisors stated, "people tripping over each other." Suggested solutions to this
problem ranged from expanding the building to provide more space, to reorganizing the
equipment in the present building to provide better working areas. The General Manager felt
the equipment was poorly organized and that there were too many places on the line where
the product had to be handled by people, thus increasing labour costs. He felt that if the
equipment could be laid out in a straighter line many of these extra people could be
eliminated and production could proceed more smoothly.
2. The infeed system: The supervisors were critical of the amount of wasted raw material
caused by capelin falling off the beginning of the infeed conveyor to the offal conveyor
below. A possible solution would be to simply move the hopper closer to the separator and to
remove the conveyor completely.
3. The distribution tables: All three of the supervisors commented on the way that the
distribution tables were organized. The inclined conveyor leading from the separator
deposited the female capelin at one end of a table. They then had to be pushed manually to
the ends of the distribution tables.
4. The weighing system: Another problem area identified during the meeting concerned the
weighing system. Capelin arriving at the end of the distribution tables were caught in either
blast freezer boxes or in plate freezer pans, depending on the freezing method to be used.
They were then moved to the weighing stations, where sufficient capelin were added or
removed to bring the package to the desired weight. Blast freezer boxes were then placed on
the roller conveyor, where they were closed in preparation for transport by forklift to the
freezers. In order to do this, the forklift operator had to manoeuvre around the packing
tables. Although this was not a problem for a skilled forklift operator, it created a potential
safety risk to those working in that area of the plant. As the plant manager put it, "they often
worked with one eye on the job and the other on the forklift." When the product was to be
plate frozen, the plastic freezer pans had to be carried from the weigh stations to the packing
tables. There, the capelin were transferred from the pans to cardboard boxes, which, in turn,
were placed into the metal freezer pans for plate freezing.
Conclusion

After reviewing his notes, the General Manager realized that his entire capelin production system
needed to be reorganized. In general, there were two key items to be addressed. First, the movement
of capelin through the plant from the raw material stage to finished product was generally inefficient.
Secondly, he considered the critical problem of the plant to be an inability to keep its freezers
working at full capacity. He knew that he needed to look at the overall plant layout to make
appropriate changes to improve production at the plant.

Study Questions

1. Given the production requirements, is the assembly line layout logical? justify your answer.
2. Without a physical expansion of the building, how can the existing floor space be better
utilized?

Exhibit 1

Existing Layout Of Processing Area

 Capstick Muffler - Cash Budgeting

On February 25, 1990, Gerald Capstick, proprietor of Capstick Muffler, was planning the
relocation of his muffler shop to the Northside Industrial Park, North Sydney, Nova Scotia. The
relocation was scheduled for May 1st. In particular, Capstick was preparing monthly cash budgets
for the first year of operation at the new location to determine operating line of credit
requirements.

Company and Project Background

Capstick Muffler was an independent automotive exhaust business located in the rural community
of Bras d'Or, which lies outside of the adjoining towns of North Sydney and Sydney Mines. The
company gained a reputation for quality work since its beginning in 1979. Capstick supplied
exhaust systems for domestic and foreign automobiles and for fishing boats. The company also
supplied specialized mufflers and pipes to local garages that lacked specialized pipe-bending
equipment.

This case was prepared by Professor Donald G Ross of St Francis Xavier University for the Atlantic Entrepreneurial Institute as a
basis for classroom discussion, and is not meant to illustrate either effective or ineffective management. Some elements of this case
have been disguised.

Copyright © 1993, the Atlantic Entrepreneurial Institute. Reproduction of this case is allowed without permission for educational
purposes, but all such reproduction must acknowledge the copyright. This permission does not include publication.

Unfortunately, Capstick Muffler's potential had been restricted by its rural location and cramped
operations. Capstick found it hard to attract customers to his muffler shop in Bras d'Or some eight
kilometres from the population centre of the Northside. As well, the muffler operation only had
two operating bays because it shared the facilities with Capstick's boat dealership. The lack of
operating space had resulted in lost customers due to long queues for muffler repair work. To
overcome these constraints, Capstick decided to set up new and expanded premises for his muffler
business in the Northside Industrial Park.

Capstick's relocation to the Northside Industrial Park would place the company in the centre of the
Northside market on the main road between Sydney Mines and North Sydney. The new, expanded
premises were to consist of a three-bay steel building complete with a reception area/waiting
room. The facility was designed to enhance sales by: (1) allowing faster service, (2) having a more
central location, and (3) providing more attractive premises for customers waiting for their
vehicles.

The Northside Muffler Market

As part of the relocation decision, Capstick conducted a market study of the size and nature of the
Northside replacement muffler market. In particular, Capstick analyzed Department of Motor
Vehicle registrations for the Northside, population statistics provided by the Northside Economic
Development Assistance Corporation (NEDAC), and the results of a telephone survey of muffler
purchasing practices of 200 randomly selected Northside residents.
Market Size

NEDAC figures showed the population of the Northside to be about 25,600, with Sydney Mines
accounting for 8,510, North Sydney 7,815, and the remainder in rural areas. These residents
owned about 10,800 passenger and commercial vehicles which would normally require a
replacement muffler every eighteen months. Hence, Capstick estimated an annual requirement of
7,200 muffler jobs worth about $612,000 to $720,000 per year.

Current Market Shares and Muffler Choice Factors

The Northside muffler market is served by Capstick Muffler (15.5%), Canadian Tire (20.0%),
service stations (18.5%), Ideal Muffler (3.5%), the Sydney shops (including Midas, Speedy, and
Thruway (32%), car dealerships (6%), and Do-it-Yourselfers (4.5%). When choosing their muffler
repair shop, most Northside automobile owners (36%) rated service (good work done in a timely
fashion) as being most important, while location (27.5%) and warranty (27%) were also seen as
being very important. Price seemed a lesser consideration as only 9.5% of the surveyed muffler
buyers cited price as the most important factor in the muffler purchase decision.

Competitive Advantages and Disadvantages

Comparison of the customer's preferred muffler shop with the customer's preferred product feature
showed muffler shop choice to vary according to what the customer viewed as being most
important in the muffler purchase decision. Capstick seemed to be serving more customers who
stressed location and price, and fewer customers who stressed service and warranty. Likewise,
Canadian Tire seemed to obtain more customers based on service, price, and location, and fewer
customers who valued muffler warranties. Customers chose service stations on the basis of service
and location, while service stations lost customers on the basis of price and warranty features. The
Sydney shops attracted their Northside customers mostly on the basis of their muffler warranty but
lost them because of location and, to a lesser degree, price and service. Finally, car dealerships got
their Northside customers on warranty considerations but lost them on service and location
grounds.

The New Facility and Capstick Muffler's Competitive Edge

Capstick Muffler's new facility and increased staff would provide faster service in a more
attractive setting. The company's more central location on the main artery between Sydney Mines
and North Sydney would enhance awareness levels and be more convenient for Northside
customers. The company's product quality and warranties (lifetime on muffler) were already
competitive but needed to be brought to the customer's attention by an aggressive advertising
program.

Advertising Message

Good product, good service, and good advertising are key components for success in the muffler
business (Advertising Age, May 16, 1985). Capstick Muffler's advertising message would be
directed at increasing customer awareness of personal and quality service and guaranteed good
products. The company also intended to target female buyers because of the growing importance
of this segment of the market.

The advertising message would be directed at the Northside market through newspaper
advertising, local team sponsorship, household flyers, calendars, pens, & other novelty items.
Following is a sample Capstick Muffler message: "Your neighbours at Capstick Muffler guarantee
their mufflers for as long as you own your car. You get a firm estimate before work begins. Free
inspection and free installation. Even free coffee. We offer a pleasant waiting room with a play
area available for toddlers. Capstick's prices are fully competitive." The company would also use
its location to maximum advertising advantage by using large back-lit signs, attractive premises,
lawns, and entrances.

Target Market Share and Projected Cash Receipts

Capstick was targeting one-third (33%) of the Northside muffler market - about double its current
share of 15.5%. To capture the additional market, the company would rely on increased customer
awareness through increased advertising of product quality and superior location. The company
would push its product warrantee to take about 9% more of the market from other Northside
competitors (who held 42%). It would push its service, location, and good price features to take
9% more of the market from the Sydney shops (who held 32% of the Northside market).

Capstick's target of 33% of the Northside replacement muffler market (estimated at $666,000 in
1989) supported a projected base sales level of $219,780 plus an inflation increase for his first
year of operations. (See Exhibit 1) There would be substantial variation in monthly sales revenues
because of seasonality in muffler demand - the peak months are April, May (heavy), June (heavy),
July, and August. (See Table 1)

Table I

Percentage of Yearly Sales by Month

Month % Month % Month %
May 11.6 September 7.3 January 6.2
June 11.9 October 6.5 February 7.3
July 9.2 November 7.3 March 8.8
August 9.7 December 4.2 April 10.0
Source: Company Records

Finally, in forecasting his new facility's first-year sales, Capstick projected a 5% inflation rate
base, increase in prices to take effect on May 1st. Capstick felt that general inflation-rate-induced
increases in costs could be passed on through corresponding increases in sales prices.

Projected Cash Expenditures

Capstick based his expense projections for the year (see Exhibit 1) on (1) his previous years'
experience, with adjustments where necessary for increased costs due to the new larger shop, (2)
his in-town location, (3) his use of debt financing to establish his new shop, (4) the
implementation of a new promotion strategy, and (5) the current inflation rate.

Production supplies were a major expense for the muffler shop: the cost of mufflers was 38% of
sales and the cost of welding supplies was 4% of sales. Although the cost of mufflers could vary
somewhat, Capstick expected no change in the percentage cost of welding supplies. The mufflers
and welding supplies were purchased on 30-day terms in the month preceding the sale. Wages,
also a major expense, were paid out equally over the year.

Another major expense was the financing charges on the $121,500 bank loan being negotiated by
Capstick to finance the new shop. Interest and bank charges were to be paid monthly, with interest
calculated on the outstanding loan balance at a floating rate of interest of prime (currently 12%)
plus 1%. A $1,012.50 principal repayment on the loan was also payable monthly. Bank charges
were estimated to be $50 per month (net of inflation).
Capstick's new promotion strategy was also expected to result in substantial cash expenditures. To
launch his new muffler shop, Capstick intended to spend about 20% of his yearly advertising
budget in April on "Opening Soon" messages and 30% in May on 'Now Open" messages. This
heavy up-front expenditure was also intended to impress Capstick's quality and accessibility on
the market right at the start of the peak season period. The remainder of the advertising budget
was being spent equally over the remaining ten months to sustain customer awareness levels.
Advertising purchases were made on 30-day terms.

Capstick's depreciation expense was also expected to increase to about $5,400 because of the
acquisition of new capital assets.1 The remainder of Capstick's expenses (with the exception of
income taxes) were expected to be incurred, and paid for, equally over the year. Finally, because
Capstick planned to incorporate his new muffler shop, it would have to pay income taxes at the
rate of 22%.2 Although this expense would be paid after the company's fiscal year-end, Capstick
planned to include it in his projected April 1991 cash disbursements to assist in cash flow
planning.

Other Information:

To handle unexpected purchases and minor acquisitions, Capstick wanted to have about $10,000
available at all times preferably in cash but alternatively, in standby lines of credit, or a
combination of cash and standby lines of credit.

1Capstick Muffler records depreciation expense at its maximum allowable Capital Cost Allowance under the Income Tax Act.

2
Capstick Muffler Limited will be a Canadian-controlled private corporation eligible for the small business deduction.

Required

Prepare monthly cash budgets for Capstick Muffler for the year beginning May 1, 1990, to
determine operating line of credit requirements. A superior answer will include a sensitivity
analysis on the principal assumptions used to construct the cash budget. State clearly any
assumptions used in your cash budget and discuss the importance of those assumptions on the
prediction of the muffler shop's cash needs.
 Exhibit 1

Capstick Muffler Limited

Projected Income Statement
For Year Ended April 30, 1991
Sales (219,780 * 1.05) $230,769
Cost of Mufflers Sold 87,692
Gross Profit $143,077

Expenses
Accounting & Legal $1,575
Advertising & Promotion 12,600
Insurance 4,200
Interest & Bank Charges 15,701
Miscellaneous 263
Welding Supplies 9,231
Civic Taxes 1,050
Utilities 6,300
Vehicle 2,100
Wages & Benefits 57,645 110,665
Net Income before Depreciation 32,412
Depreciation 5,400
Net Income before Income Taxes 27,012
Income Taxes 5,943
Net Income $21,069
 MACDONALD FLOORING COMPANY
On July 10, 1989 George London, commercial lending officer of Maritime Bank, Sydney, Nova
Scotia sat down and gathered his notes on the meeting he had just attended with Cathy Palmer, the
Bank's lawyer, and John MacDonald, owner of MacDonald Flooring Company. George had called
the meeting to advise John that the Bank was concerned about the deteriorating financial state of
MacDonald Flooring.

As the Company's banker, George London had to assess the Company's prospects and determine
whether and how it could be turned around, or if the Bank should call its loans and place
MacDonald Flooring into receivership.

After John had left, Cathy stayed to discuss the Bank's position. She advised that if bankruptcy
and receivership proceedings were to be initiated, the process should start as soon as possible.
George noted her advice, and assured her that he would call her in a few days.

Company History

MacDonald Flooring Company was established in 1981 by John MacDonald in Sydney, Nova
Scotia (Cape Breton). John was an experienced flooring supervisor. The business installed
flooring, and expanded rapidly during the early 1980s. In 1984 the business was relocated to a
larger warehouse in the same area. Sales continued to grow rapidly, from $863,000 in 1985 to $1.7
million in 1987 (see Exhibits 1 and 2). Fixed assets were increased, and a retail outlet was opened
in 1987. The retail outlet was a ceramic tile and bath boutique for which new premises were
leased.

Despite the fast sales growth, George London was concerned by the Company's rapid changes, its
frequent overextension on its line of credit and an unfulfilled debenture covenant requiring audited
quarterly financial statements. The overextensions had so concerned him that he had placed the
Company on the Bank's watch list until February 1988; at that time the account had seemed to

This case was prepared by Gordon S. Roberts, Bank of Montreal Professor of Finance and Linda P. Hendry, Finance Lecturer at
Dalhousie University for the Atlantic Entrepreneurial Institute as a basis for classroom discussion, and is not meant to illustrate
either effective or ineffective management.

Copyright 1991, the Atlantic Entrepreneurial Institute. Reproduction of this case is allowed without permission for educational
purposes, but all such reproduction must acknowledge the copyright. This permission does not include publication.

be stabilizing. However, financial statements continued to be unaudited, provided only semi-

annually, and reached the Bank several months after the statement date.

In 1988 the Company suffered its first loss, one of $7,000. A significant loss of $97,000 resulted
during the first six months of 1989 (up to the end of March).

Current Business Activities

The Company's market was mainly in industrial Cape Breton. A close look at the receivables
listings revealed generally good quality accounts. Several large accounts were with reputable
firms and government organizations. Organizations with this type of account normally took
 advantage of a strong market position to extend payables beyond due dates. As a result, the
Company's average collection period was long -- 87 days in 1986, 89 days in 1987 and 62 days in
1988. The credit terms given were net 30 days with 60 to 90 days on large accounts. As of May
1989 the ages of accounts receivables were as follows:
CURRENT 30-59 DAYS 60-89 DAYS 90 DAYS +
WITHIN TERMS PAST DUE PAST DUE PAST DUE
67% 19% 2% 12%

The Principal in the Company

Although John MacDonald was a good estimator and foreman, George London felt he lacked an adequate
financial background and knowledge of the controls and systems needed to run his expanded business.
John's main function was to cost jobs and supervise their completion; he placed total reliance on his staff
and the Company's chartered accounting firm to carry out the tasks needed to control operations. John did
not even verify that these tasks were carried out properly, or at all. It was not until an accountant was
hired in mid-1988 that the Company had the internal means to properly account for each operation and to
obtain financial information to make decisions.

During 1988 there was a $42,000 increase in the amount John MacDonald owed to the current asset
account "Due from shareholder." This increase was due mainly to a separation settlement with his
common-law wife and former shareholder. To assist in reducing the shareholder receivable, John
transferred personal property (land and a building) to the Company. The building was rented to an
unrelated company at $1,800 per month with a three year lease.

Company Facilities

MacDonald Flooring Company paid $1,000 per month rent for the warehouse that housed its flooring
installation operation. Its new premises, for the ceramic tile and bath boutique, included a large retail
showroom, warehouse, and office space. The lease agreement was for $2,667 per month and expired in
1991 with an option to renew for an additional five years at renegotiated rates. George London viewed
the facilities in May 1989, and he considered them adequate for the operations of the Company.

The Banker's Risk Assessment of the Company in April 1989

The Company financial statements were unaudited and semi-annual, which violated debenture covenants
requiring audited quarterly financial statements. Another covenant required capital expenditures to be less
than $25,000; this amount was exceeded without prior approval from the Bank when the Company
opened the ceramic tile and bath boutique. Considering the Company's apparent lack of internal financial
controls and problematic information systems, George identified financial reporting as a significant risk
for 1987 (and prior years).

Partly in response to George's concerns, in 1988 the Company hired Eva Levesque a CA student, to
provide day-to-day accounting for operations. She discovered that the Company was not remitting sales
tax on purchases. Major suppliers were not adding sales tax to delivery invoices, leaving the
responsibility to MacDonald Flooring, as purchaser, to remit the tax. For example, on a $1,000 invoice,
sales tax of $100 (10%) should have been remitted directly to the provincial government. These taxes
were neither being remitted, nor recorded by the accounting procedures. When Eva brought this oversight
to John's attention, he called in the Provincial Tax Commission, who discovered unrecorded sales tax
amounting to at least $175,000.
Several other factors contributed to the 1988 loss. Sales declined significantly, and would have been even
lower were it not for the ceramic tile and bath boutique. The only reason John could give for the decline
was the delay of several large projects until late 1988. Operating expenses were up by $129,000 from
1987. These expenses included costs associated with the property previously owned by John and
transferred in 1988 to the Company. Inventory, fixed costs and capital expenditures required for the
ceramic tile and bath boutique also contributed to increased 1988 operating costs.

The Sales Tax Liability

The Provincial Tax Commission did a four year audit which revealed $140,000 in unremitted sales tax for
the years 1985 to 1989. The Company was also assessed an interest penalty of $35,000. The full amount
of the sales tax owing was to be paid by December 31, 1989. The interest portion would be forgiven if
full payment was made by the end of the year; this arrangement would give MacDonald Flooring about
six months to find the money.

Eva restated the Financial Statements for 1987 and 1988 and the remaining amount, $38,544 for the years
1985 and 1986, was charged as a prior period adjustment to retained earnings on the 1988 statement. Of
the total adjustments made, $35,276 was applicable to 1987, $86,304 to 1988 and $14,902 to 1989;
according to Eva, these amounts should have been charged to income for the respective years. Other
effects of the restatement were to increase income tax receivable by $8,819 in 1987 and $6,835 in 1988;
and to increase the accrued liabilities by the lost retained earnings (see Exhibits 3 and 4). She sent the
revised statements to the Bank with her explanation and a copy of the Provincial Tax Commission report.

Because the adjustments were made directly to revenue and net profit, George found it difficult to
determine if gross profit was accurate. Gross profit, although improved in 1988, was well below 1985 and
1986 levels. George felt that the sales tax should be included in material costs and gross profit adjusted
accordingly.

Banker's Investigation of Company Receivables and Inventory

John assured George that there were more than adequate assets in the form of receivables and inventory
(including work in progress and contracts in hand, if completed) to liquidate the debt owed to the Bank.
To validate this important statement, George examined the contracts on hand, and evaluated each one
based on discussions with John or other employees of MacDonald Flooring. A detailed analysis of three
typical contracts appears in Exhibit 5.

Inventory consisted of ceramic tiles, marble products, retail and commercial vinyls and carpeting. The
inventory was of good quality, with limited evidence of obsolescence. Approximately 25-30 percent of
inventory held at any time was related to specific contracts; the balance was primarily made up of retail
products, with a small amount held for commercial repair jobs.

Since only the retail inventory would have been available to cover the bank debt -- commercial inventory
would have been used in contract completion -- George was concerned that its resale value would be low
because it was in small lots. When he checked the file of another retail ceramic tile company that had
gone into receivership the year before, George found that the receivers had contacted two competitors.
After receiving inventory listings and tours of the premises, the competitors had offered around $10,000
for inventory costing $30,000. Not satisfied with realizing 30 cents on the dollar, the receiver had next
invited proposals from liquidators to auction the inventory to the public.
Economic Forecast

George consulted the economic forecasts regularly prepared by the Bank's Economics Department.
George began with a survey of leading economic indicators which showed that the Canadian economy
was beginning to slow down. The Bank's economists believed that interest rates would remain high as
long as Governor Crow of the Bank of Canada remained concerned about inflationary pressures; these did
not seem to be easing.

The economists believed that as a result of Canada's high interest rates and the unusually wide spread
between US and Canadian interest rates, the Canadian dollar was overvalued with respect to the US
dollar. The Canadian dollar was expected to fall by year end to around 81 cents US from its current value
of 84 cents.

An economic slowdown was forecast in the Atlantic region as well. Traditionally, Cape Breton was
economically depressed by comparison with Halifax and other parts of the province. By creating
additional record-keeping costs, the Goods and Services Tax (GST) to take effect in January 1991, was
expected to have a negative impact on the construction industry. MacDonald Flooring expected a greater
impact on its ceramic tile and bath boutique than on its flooring installation business because of the
greater number of transactions in the retail operation.

Industry Scan

Although there was no real competition in the immediate area, there was stiff competition from Halifax.
As a Cape Breton company, MacDonald Flooring had an advantage in bidding on government contracts
in Cape Breton. However, costs and quality control had to be maintained carefully on commercial
contracts, because reputation was important to specification writers who influenced selection of
contractors on these jobs. Specification writers for commercial and government contracts detailed
materials requirements such as ability to meet standards, ease of application, and pricing (including
freight costs). They also often recommended specific contractors whose work was known to meet their
needs.

The Alternatives for Management and the Bank

Receivership

At the meeting with George London and Cathy Palmer, John MacDonald was advised that the Bank was
unhappy with the Company's financial situation, particularly in view of the sales tax liability. One option
was for the Bank to issue letters of demand for the two loans outstanding in the Company's name (one
operating and one term) as well as a letter requiring John to cover his $150,000 personal guarantee in
favour of the Company. John did not appear to be overly surprised, and said that he was not able to
generate enough money to pay the Bank out immediately.

The operating demand loan was a revolving line of credit up to $275,000 at prime plus 3.5%. As of
March 31 the loan was over overextended to $350,000. The term loan, also demand but non-revolving,
was granted in 1988 for $50,000 to replace working capital used for leasehold improvements, equipment,
start-up costs of the retail outlet and cost of its inventory. This loan was to be repaid over 36 months at
$1,400 per month plus interest at prime plus 2.75%. The outstanding amount at March 31 was $40,200.
The margin formula was 75% of the account manager's estimation of assigned receivables worth after
deducting accounts aged 60 days or more, accounts in dispute and 50% of inventory at cost. The
maximum available under inventory was $125,000, with inventory to be verified quarterly by in-house
financial statements. The margin formula was applied to both loans.
The Bank's security on these loans was a general assignment of accounts receivable and a section 178
security on inventory as well as the $150,000 limited personal guarantee.

Injection of New Capital

John said that a possibility existed for him to have another investor put cash into the Company. He asked
how much cash the Bank thought he should have in order for the Bank to continue its loans to his
company, George said the Bank was not prepared to continue, but that a cash injection of at least
$150,000 would be needed to offset the provincial sales tax liability. John left the meeting indicating that
he was going to discuss the situation with his lawyer.

Implications for the Bank

Cathy told George that bankruptcy would have to be initiated in order for the Bank's security position to
take priority over the sales tax liability to the Province. Under Nova Scotia law, this meant that, should
bankruptcy be initiated, a receiver and a separate trustee in bankruptcy would have to be appointed. Their
fees would reduce the amount the Bank would receive.

George recalled only too well how time consuming receivership and liquidation could be. There was
always the possibility that either the customer or the Bank would initiate legal action requiring long and
costly conferences with the Bank's lawyers, and days in court. Also, receivers would need to consult with
the Bank on liquidation negotiations which are often quite complicated.

Placing a Company into receivership could also create negative public relations for the Bank. Last year,
the decision to put a receiver into another Cape Breton company had triggered a phone call from a
Maritime Bank director who lived in Cape Breton. The director had received a letter from his riding MP
stating that "in his view the Bank had moved precipitously against the Company." The MP had asked the
Bank director to take corrective action.

Implications for the Company Principal

George knew that John MacDonald would be under severe strain with either alternative. Should his
Company be forced into receivership, John would also be forced into personal bankruptcy. If he found
another investor to inject cash, the investor would want some responsibility for Company operations;
John would thus lose some of the control he had enjoyed to date. Should the Company continue, the Bank
would also be likely to exert considerable control over operations.

George realized that he had to quickly decide what to do. He knew that Cathy was right; if bankruptcy
and receivership proceedings were to be initiated, the process had to be started as soon as possible.
 Exhibit 1

Macdonald Flooring Company

Unaudited Balance Sheet ($ 000s)

Source: Bank Files and Company Records

 Exhibit 2

Macdonald Flooring Company

Unaudited Income Statement ($ 000s)

Source: Bank Files and Company Records

 Exhibit 3

Macdonald Flooring Company

Restated Balance Sheet ($ 000s)

*
Figures as restated in the 1988 F/S and March 31, 1989 interim F/S.
 Exhibit 4

Macdonald Flooring Company

Restated Income Statement ($ 000s)

*
Figures as restated in the 1988 F/S and March 31, 1989 interim F/S.
 Exhibit 5

Detailed Analysis Of Selected Accounts Receivable

Source: Company files and Interviews