The Royal Pets Hotel and Spa

Background

You are an Analyst for the professional service firm, BUSI 1043 LLP. Your firm specializes in providing a wide variety of internal business solutions for different clients. One of the major partners at your accounting firm, Justin Medakiewicz, has just dropped of a mountain of files and other paper work on your desk with a note at the top marked urgent. As a result, you put your other work aside and begin to sift through the information.

Additional Information

You are providing advice for The Royal Pets Hotel and Spa. Established in 1982, the Royal Pets Hotel was built with one thing in mind, Luxury Boarding Kennels. They maintain amongst the highest staffing levels and definitely standards in Ontario. The benefit of their superior care is the highest health and safety standards for your pet and peace of mind for you and your family. BUSI 1043 LLP has been providing consulting services for this publicly traded firm for over 5 years. The Royal Pets Hotel and Spa has a year end of December 31st. You were not originally assigned to the engagement but were given the task after the original analyst suddenly left for a job in Muskoka.

The Royal Pets is currently in the process of a major expansion and it is looking into financing alternatives for its acquisition of manufacturing equipment to be used in its Hotel and Spa.

The Royal Pets is currently in a cash crunch, although its sales and production have expanded considerably over the past 10 years. All of its other key ratios are in good order, which is allowing The Royal Pets to look at a variety of ways to finance its next expansion. The founder and major shareholder, Katniss Everdeen, is concerned about maintaining a healthy current ratio and debt to equity ratio as she believes this will be important in the future and the minority shareholders have shown some concern over these ratios in the past.

Your firm has been hired by The Royal Pets to assist it in exploring the various alternatives as described in Exhibit I. They would like your detailed analysis. This analysis should incorporate calculations, impact on the financial statements, and more qualitative impacts as you deem appropriate in the circumstances (such as impact to corporate structure, overall leverage, advantages and disadvantages).

In addition, in order fully understand the situation, The Royal Pets would like you to prepare journal entries for the first year for alternatives one, two and three and the potential impact they will have on The Royal Pets ratios.

You have been made aware that the auditors will be arriving in a few months and The Royal Pets has asked you to ensure that all accounting recommendations are followed. In addition, The Royal Pets have a few other items that it would like you to comment on prior to the auditors arrival.

Required

Prepare the draft report to The Royal Pets.

Exhibit I

Acquisition Arrangement #1:

The Royal Pets could finance the purchase of the machine by issuing bonds.

$1,000 bonds would be issued totaling $1 million, for 10 years and a stated interest rate of 8%.

The current market value for similar bonds is 6%.

Interest would be paid semi-annually with the bonds being issued January 1, 2016.

Acquisition Arrangement #2:

The Royal Pets could purchase the asset for $1 million and obtain a secure loan from its bank.

The terms of the loan calls for principal payments each year beginning January 1, 2016 of $100,000.

The interest is to be paid annually each January first and is fixed at 9%.

The Royal Pets are required to maintain a specific debt to equity ratio or the loan will become immediately payable.

Acquisition Arrangement #3:

The Royal Pets could issue common shares or preferred shares to finance the acquisition of the machinery.

The Royal Pets is a public company with the founding member owning 51% of the common shares currently outstanding (currently there are 4.5 million shares outstanding in total).

The current market price per share is $14.

Exhibit II - Other Information

During the year, a dog slipped and fell while playing with an employee and broke their leg. The pet owners have subsequently sued The Royal Pets for $800,000. The Royal Pets lawyers do not believe that the $800,000 lawsuit will be successful, but do believe they will have to pay an amount between $300,000 and $600,000.

The Royal Pets intends to put on a contest this year with a coupon attached to each day of hotel stay. Any customer who collects five coupons may send them to The Royal Pets for a dog or cat t-shirt of their choice. The Royal Pets would like some guidance on how to account for this.