Reference no: EM133010841

Problem 1: Prepare a basic income statement forecast for the subsequent fiscal year, using a percentage of sales approach and using information included in the materials below to support assumptions that correspond for each revenue and expense. Each line item (e.g., marketing expenses) should have a note and an explanation on how it was calculated.

• Ms. Matthews has asked for your help in developing a financial forecast for 2018, using the 2017 income statement as a reference point.
• "Sales are forecasted to grow 13% in 2018, due in large part to a rebound in the North America retail segment, which consists of all the sales in cafés across the US and Canada," explained Ms. Matthews. "72% of 2018 sales are expected to be from North American cafes. We are working on having our new cafes located in several Macy's department stores, as well as a national book chain, but nothing has been finalized as of yet. Nonetheless, we are exploring more and more partnerships in our growth strategy to help spread the risk and the costs with a less leveraged organization."
• "12% of 2018 sales are anticipated to be from the wholesale segment, which consists of all products that are sold as pre-packaged items (e.g., bags of coffee beans, bakery products, or pre-made coffee mix), primarily in grocery stores and travel retail at airports. We have been approached by a major grocery chain in Europe to expand our wholesale offerings in their 400 locations across 15 countries. There may be further opportunity to expand our popular blended products in Eastern Europe, as well."
• "The international segment consists of international cafes not located in the US or Canada. These cafes often operate through licensing and franchising agreements with local partners in the foreign countries. The segment is expected to continue to grow with our aggressive franchise expansion in Asia, but the strengthening US dollar is reducing our return on foreign sales. Nevertheless, there are still tremendous opportunities for international franchising, including Latin America. Overall, I want your forecast to indicate the total dollar amount that each of ACH's three segments will generate in 2018."
• "In terms of our gross margin, there are several positive and negative factors impacting our ability to control costs. There is a lot of uncertainty regarding the recent trade wars between US and several Asian countries that host key suppliers for some of our raw materials (coffee beans), which is expected to negatively impact our 2018 margin by 2% versus our 2017 margin. However, the rising American dollar has increased our buying power, which will mitigate this impact by about 1%. We also have to switch to a more expensive supplier for our gourmet coffee, due to some natural disasters wiping out the coffee fields of our major supplier, which will impact gross margin by -1%. This risk continues to grow for us, as our supply chain stretches globally. We plan on raising our prices to match the increased share of gourmet offerings, leading to a 4% positive impact on gross margin. Taking all these factors into account will help forecast what our expected 2018 gross margin will be."
• With the rebranding of ACH into a more premium, hipper coffee provider, Ms. Matthews has indicated that advertising and marketing will grow to 8% of sales in 2018. Minimum wage hikes will also lead to a 4% increase in general and administrative costs, which mostly consist of employee wages. "I'm hoping that higher wages will help with our employee turnover issues," explained Ms. Matthews. "The turnover issues are also part of our deteriorating customer service, as we keep having to train new employees on the job, rather than having them take our two week ACH employee training course."
• In order to help ACH restore long-term profitability, Ms. Matthews intends to close several unprofitable stores, admitting that the company may have initially over expanded during its "renaissance." This move will lead to $30M in lease termination payments to landlords in order to compensate them for the early exit of ACH from leased premises. These lease payments will be treated as an expense on the income statement. ACH will finance these payments with the sale of one of its head office properties, resulting in a $20M gain to be recognized in the income statement. The entire head office is now moving under one roof to ensure strategic alignment across the organization. Some intangible assets will be sold, consisting mostly of licenses, resulting in a gain of $15M. The sale of the head office properties will result in depreciation being lower by 25% in 2018. The sale of assets is expected to close in the first two weeks of January.
• Excess cash from the disposal of assets (after the lease payments have been settled) will be used to pay down debt obligations, as ACH has had limited access to capital due to the significant amount of long-term debt on its books and deteriorating cash flow. ACH plans on paying down $40M of debt right away, with the remaining debt having an associated interest rate of 8%.
• The tax rate is expected to be consistent with 2017. Finally, research, development and IT costs are expected to triple in 2018 as ACH prepares to launch a mobile app for ordering and customer rewards.