romacorralfoods_additional information cma

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Module 3 Assignment 5

Practice Case Examination

Additional Information

(Time Allowed: 4 hours)

Notes:

i) Candidates must not identify themselves in answering the question.

ii) All answers must be written on official answer sheets or in official electronic files.Work done on the question paper or on the Backgrounder will NOTbe marked.

iii) Included in the examination envelope is a standard supplement consisting offormulae and tables that may be useful for answering the question.

iv) Examination materials MUST NOT BE REMOVED from the examinationwriting centre, except for the Instruction Sheet to Electronic Exam Writers,if applicable.All used and unused answer sheets, working papers,Backgrounder, Additional Information, the supplement and, if applicable, a USBkey containing electronic answer files must be sealed in the examinationenvelope and submitted to the presiding officer before the candidate leaves theexamination room. Candidates writing the examination electronically must keepthe Instruction Sheet to Electronic Exam Writers, which provides instructions foruploading their responses following the examination.

v) Only the following models of calculators are authorized for use on the Case

Examination:

1. Texas Instruments TI BA II Plus (including the professional model)2. Hewlett Packard HP 10bII+ (or HP 10bll)3. Sharp EL-738C (or EL-738)


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Additional Information Practice Case Examination M3A5

Page 2 (8 pages) CMA Canada

RomaCorral Foods Ltd. (RCFL)Additional Information

Update

As a result of the economic recession that began at the end of 2010, Canadianconsumers continued to reduce discretionary spending in the first six months of 2011.Sales at Canadian restaurants fell, and experts predict that 2012 revenues will drop by2.5%. Sales at full-service restaurants are expected to show the largest decline (3%) ascost-conscious consumers switch to limited-service restaurants, where sales areexpected to decline less severely (1.5%).

Many full-service restaurants with prime costs (direct materials and labour) greater than65% of sales recorded losses in the first half of 2011. 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 2011 and are predicted to remain relatively strong, resultingin an average increase in sales of 2% per year over the next two years.

In fiscal 2011, RomaCorral Foods Ltd. (RCFL) experienced a 1.5% decrease in averageannual sales per restaurant but an increase in overall sales as a result of opening sixnew restaurants. Overall profits increased, and RCFL paid a dividend of $2 per share onboth the common and preferred shares.

The impact of the recession on the hospitality and food service industries in Europe wasmore severe than originally expected. As a result, EFLs European hotel and restaurantoperations experienced significant reductions in sales and profits. Realizing that the

Canadian restaurant industry was also affected by the recession, the EFL board ofdirectors reduced its expectations for RCFLs growth in net income after taxes. Insteadof a growth rate of 20% per year, the board indicated to Raymonde Plante that itrequired RCFL to achieve an after-tax net profit growth rate target of 5% over the nexttwo years (i.e. net income of $42,901,583 in fiscal 2013) and to pay a dividend of $2 pershare annually on both common and preferred shares. The board also indicated thatEFL would not be able to provide RCFL with any financing for at least the next threeyears.

Senior Staff Meeting July 2011

Plante assembled the senior staff to brainstorm ideas for reaching EFLs specifiedtargets.

Prosad Singh indicated that RCFL is still holding the options on 12 parcels of land inlocations that would be suitable for opening 7 Roma and 5 Corral outlets. Each optiongives RCFL the right to purchase the designated parcel of land for an additional$550,000 before January 1, 2012, at which time the options will lapse. Planteacknowledged that opening new restaurants would increase RCFLs income butquestioned the feasibility of opening 12 new outlets over the next year without any


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Practice Case Examination M3A5 Additional Information

CMA Canada Page 3 (8 pages)

financing from EFL. She wondered whether it was possible to achieve EFLs targets byopening only Roma or only Corral outlets.

Prosad Singh also reported that his marketing manager had recently confirmed the newloyalty points program which had been launched in early fiscal 2011 was turning out to

be very successful. Singh reminded everyone that the program is available through allthe restaurants (and the coffee shops, if the plan proceeds). Customers earn one pointfor every $10 spent. The points are accumulated and the customer can then redeem thepoints on meals in the restaurants. The redemption is as follows: 100 points represent$5. So the value of each point is $0.05 for future purchases. At June 30, 2011,customers had accumulated about 20 million points which translates into a futureobligation to redeem the points worth $1,000,000 (5 cents per point). The adjustment forthis loyalty points program has not yet been made on the 2011 statements as currentlypresented. In his discussions with Alicia, the accountant, Singh was told that underIFRIC 13, the loyalty points earned at the time of the sale are to be reported. In otherwords, each sale is broken down into two parts: the meals purchased which would be

recorded immediately as revenue, and a liability for the loyalty points that are also sold.Jackie Browne suggested opening a chain of coffee shops in addition to, or instead of,new restaurants. Through her contacts at EFLs coffee shop division, she knew that theoverall profits for this division had increased over the past year. Connie Bucknerconfirmed that the coffee shops seem to have been relatively unaffected by therecession and indicated that she had learned a little about EFLs coffee shop operationswhile she was in London.

Josh Belli complained that some Roma outlets that supply fresh bread products to theCorral restaurants had not met the profit margin target because head office had set thetransfer price at 60% of market price. Buckner indicated that all of EFLs European

restaurant chains obtain their bread products from local bakeries and suggested that itmight be better for RCFL to do the same. The bakeries that currently supply desserts toRCFLs restaurants could also provide a full line of bread products.

Browne did not want to absorb the higher cost of outsourcing. Belli did not like the ideaof relying on an external supplier and pointed out that, according to customer surveys,diners at Roma restaurants find the smell of baking bread appealing.

Plante indicated that all available information on these ideas should be forwarded toAlicia King, who would analyze the data and present a report for their review.

Roma and Corral Expansion

As a first step, King determined the 2011 average income per restaurant in operation formore than one year and the performance targets for each division (see Appendix A).During 2011, all restaurants met the sales target and most met the net profit margintarget.

Plante indicated that she expects the economy to stabilize soon and that the averagesales per restaurant will remain at the fiscal 2011 levels in the foreseeable future. She


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also indicated that January 1, 2012, is the earliest any new restaurant could be ready toopen.

Singh indicated that, as mid-range steak houses, Corral outlets have higher menuprices and more expensive dcor than the more casual, family-oriented Roma outlets.

He provided the following summary of the required capital investments for each newrestaurant:

Roma Outlet Corral OutletLand (including cost of option) $600,000 $600,000Building $4,500,000 $5,000,000Furniture and equipment $1,000,000 $1,600,000

The seven locations for proposed Roma outlets would not be suitable for steak housesbecause existing steak houses nearby are Corral competitors. Initial promotionalcampaigns for the new Roma restaurants would cost approximately $50,000 per outlet.

The five locations for proposed Corral outlets are close to existing Roma restaurantsthat all have sufficient capacity to supply bread products to the new steak houses. Initialpromotion costs would be minimalthe Corral outlets would simply be added to thecurrent promotions for the Roma outlets.

Proposed Roco Coffee Shop Chain

Although the Canadian coffee shop market is currently dominated by a few large chains,Singhs research showed that there is room for specialty coffee shops of a style similarto that of EFLs European chain. He indicated that coffee shops are best located in high-traffic areas and that such locations could be leased at an average annual cost of

$45,000, including maintenance and repairs. In his view, RCFL could successfully open30 Roco Coffee Shop (Roco) outlets per year and the earliest the first outlets could beopened is January 1, 2012.

Singh provided King with the following sales probability chart:

Annual Sales per Outlet Probability$800,000 $950,000 30%$950,000 $1,050,000 50%

$1,050,000 $1,200,000 20%

Buckner contacted EFLs head office and discovered that EFL would be willing to

provide staff support to help RCFL set up a coffee shop chain and establish thenecessary training and support systems. She projected some annual operating resultsfor a hypothetical Roco Coffee Shop (see Appendix B). For simplicity, she assumed thateach outlet would be able to generate $1 million in annual sales. Her cost estimateswere based on information obtained from Singh and EFL, which she appropriatelyadjusted to reflect costs that could be expected in Canada.


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Outsourcing the Bread Products

Plante indicated that she had set the transfer price at 60% of market price to reflect thevariable cost percentage of sales incurred by a typical bakery. Kings preliminaryanalysis revealed that the average costs associated with baking bread products per

Roma outlet in fiscal 2011 and the market price for these products were as follows:Bread Products for

Roma OutletsInternal Use Only

Bread ProductsProvided to aCorral Outlet

Romas variable production costs:Direct materials $ 8,000 $ 6,000Direct labour 9,000 6,750Other variable costs 3,000 2,250

Total variable costs $20,000 $15,000

Market price if acquired from external

source $30,000 $22,500

The investment in bread-making equipment per Roma outlet is $25,000, which isamortized over a 10-year expected life. At the end of fiscal 2011, the total book value ofthis equipment for all Roma outlets was $1,200,000; this equipment can be sold for$1,300,000 if RCFL decides to outsource bread products.

Additional Information

1. As at June 30, 2011, there were 7 million common shares and 1 million preferredshares of RCFL outstanding.

2. In addition to providing RCFL with 75% mortgage financing for new land andbuildings, the Capital Bank of Canada is willing to refinance the existing mortgages(without a penalty) for up to 75% of the fair value of the land and buildings of existingrestaurants, provided that the ratio of long-term debt (including the current portion) toequity does not exceed 2 to 1. As of June 30, 2011, the net fair value of RCFLs landand 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-yearterm, amortized over 25 years) at 3.5%.

3. 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 in20 years and the fair values of other assets are expected to equal their book values.

4. In reviewing RCFLs process for selecting contractors, King noticed that the sameconstruction company had been chosen to build the last few new restaurants, eventhough its bids were not always the lowest. Further investigation revealed that, ineach case, the same purchasing officer (Lyle Baird) had convinced Singh to acceptthis contractors bids. Baird had argued that the contractor was reliable and used


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only good-quality materials and skilled labour. It was also determined that thepresident of the construction company had loaned Baird $100,000, interest free, sothat Baird could send his wife to the United States for specialized medical care.There is no evidence to suggest that the contractor either asked for or expectedpreferred treatment in return for the loan. However, other purchasing officers

indicated that some of the lower bids were made by equally reputable contractors.

5. Anecdotal evidence suggests that the unusually high turnover of quality servers isrelated to the reporting of gratuities as income on T4 slips. This is not commonpractice in the industry. In general, Corral outlets experience a higher turnover ofservers and other staff than Roma outlets.

6. Expenses related to breakage, cash register and alcohol inventory shortages, cutleryreplacement, and customers leaving without paying their bills vary significantly fromone outlet to another. These expenses ranged from $24,000 to $86,000 per outlet infiscal 2011. King discovered that the time delay mechanism on the restaurant safesis used for protecting receipts overnight but is rarely activated during the day, since itis customary for each restaurant to pay local expenses from the cash on hand. Shealso learned that the percentage of customers who leave without paying is higher forRCFL restaurants than for other, comparable restaurant chains.

7. Servers are not charged for broken dishes or customers unpaid bills. However, if thenumber of such occurrences connected to a particular server becomes excessive,that server is fired.

8. Routinely, bank deposits are made daily between 7 p.m. and 8 p.m., after the earlydinner sitting. There has been a significant increase in the number of attemptedrobberies of RCFL employees making bank deposits, although there is no apparent

focus on particular restaurants.

REQUIRED:

As Alicia King, analyze the current situation of RomaCorral Foods Ltd., update theenvironmental scan, analyze the various issues and alternatives facing RCFL, andprepare a report for the senior management team advising them on the business andfunctional strategies to follow in order to meet the targets imposed by the parentcompany, EFL. Your report should also address any other organizational issues andconcerns requiring attention and a revised statement of financial position and statementof comprehensive income for the year ended June 30, 2011, if any adjustments are

required. Include details of your analyses, supported recommendations and an actionplan for implementing your recommendations. In undertaking this task, you will need totake into consideration your background knowledgeof the company and industry as wellas the additional information provided above.


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Appendix ARomaCorral Foods Ltd.

Selected Financial Data for a Restaurant in Each Divisionfor the Year Ended June 30, 2011

(Dollar values are in 000s except target average monthly sales per seat)

Roma1 Corral1

Sales $3,197 $4,334

Food and beverages2 902 1,468

Salaries, wages and benefits 869 1,232

Other variable costs 85 91

Total variable costs 1,856 2,791

Contribution margin 1,341 1,543

Facilities (excluding amortization)3 140 141

Selling, local advertising and promotion4 21 12

General and administration 54 58

Depreciation building 81 113

Depreciation furniture and equipment 98 129

Head office allocation5 291 291

685 744

Income before taxes 656 799

Income taxes (40%) 262 320

Net income $ 394 $ 479

Number of seats 200 180

Target average monthly sales per seat6 $1,231 $1,897

Target net profit margin 12% 11%

1 Amounts represent the average sales and expenses for restaurants that have beenoperating for more than one year. For Roma, revenues and costs associated with thetransfer of bread products to Corral are not included.

2 Costs of the Corral outlet include $15,000 paid to the nearby Roma restaurant for breadproducts.

3 The facilities costs include maintenance and repairs, utilities, insurance and alarm.4 All Corral outlets are located close to a Roma outlet. In these cases, the Roma outlet shares

local promotion and advertising costs with the Corral outlet. As a result, each outlet incurred$12,000 in selling, advertising and promotion expenses.

5 Head office costs (including regional office costs) are allocated evenly to the individualoutlets. Total head office costs were $27,456,000 in fiscal 2010 and $29,071,000 in fiscal2011. These costs are expected to be $31,200,000 in fiscal 2012 and $32,600,000 in fiscal2013 (assuming RCFL operates 100 to 115 outlets during those years).

6 The target average monthly sales per seat for performance evaluation purposes is set at85% of the benchmark. The benchmark is set at the average sales per seat achieved by therestaurant with the highest annual sales in that division.


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Appendix BProposed Roco Coffee Shop Chain

Estimated Costs and Projected Annual Operating Results

RCFL Costs (000s):

Head office systems set-up $2,000Initial promotion and advertising $500Investment in furniture, equipment and leaseholds per outlet $250

Annual incremental head office fixed costs per outlet to supportRoco Coffee Shops1 $50

Projected Annual Operating Results per Outlet (000s):

Sales $1,000

Direct materials 430

Salaries, wages and benefits 296

Local advertising and promotion 20Facilities (excluding amortization)

1 75

Amortization 25

General and administration 26

Head office allocation2 50

922

Income before taxes 78

Income taxes (40%) 31

Net income $ 47

1Facilities include the lease, utilities, alarm, maintenance and repairs.2The head office allocated costs include national advertising, training, bank charges,

interest, insurance, and some administration and management supervision.

romacorralfoods_additional information cma

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