Create-A-Candle, Inc.: A Conceptual Approach to Financing feedback.(Instructor's Note)

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CASE DESCRIPTION

The primary focus of this case concerns the borrowing needs of a start-up business, taking into account the financing feedback associated with interest expense. Instead of using the traditional iterative method for debt determination, enough information is provided so the better students could express the relationship in an algebraic construct and solve directly for the requisite loan amount. Secondary issues include developing a forecasted statement for the first year of a start-up business. The case has a difficulty level of three, and is positioned for use in junior level principles of finance courses as well as in integrated business curriculum classes for juniors. The case is designed to be taught in two class hours and is expected to require three to six hours of outside preparation by students.

CASE SYNOPSIS

Bob Fortune has spent a number of years in the candle-making industry and has decided to start his own business. Using a made-to-order approach, he is hoping to carve out a niche in the market. He has obtained $260,000 in equity investment for his business but still needs additional funds and plans to use a line of credit. To determine the amount he needs to borrow, Bob needs to develop his first year financials. Not only does he need to completely forecast his income statement and balance sheet, he also needs to determine the amount of debt financing needed to reach his target cash balance. Deriving the amount of financing needed is complicated by the financing feedback effect, wherein the more he borrows, the more interest he pays.

INSTRUCTORS' NOTES

Learning Objectives

After successful completion of this case, students will:

** create a forecast for the first year of a start-up business

** describe the impact of financing feedback on financial statements for an S-Corporation and C-Corporation

** solve for the ending debt balance of an S-Corporation which takes into account the financing feedback associated with interest expense on new debt borrowing

** solve for the ending debt balance of an C-Corporation which takes into account the financing feedback associated with the tax deductibility of interest expense on new debt borrowing

Theoretical Frameworks

To successfully analyze this case, students must be familiar with:

** Accounting concepts and terminology. Students must understand basic accounting concepts (e.g. depreciation, cost of goods sold, accounts receivable, etc.) and terminology used to present the assumptions.

** Financial forecasting assumptions. This case provides students with enough information to construct financial statements (income statement and balance sheet) for a 1-year period. Students will need to take information presented in the text and in exhibits and convert this information into financial statement information.

** Financial forecasting methods. Students must understand the basics of forecasting financial statements (transaction-based) and the interrelationship between the income statement and balance sheet.

** Financing feedback. Students should be aware of the debt/interest loop encountered when forecasting financial statements. They should understand the meaning of financing feedback as it relates to new debt borrowing.

ANCILLARY READINGS

Financial forecasting assumptions. A realistic and comprehensive financial planning example is provided in:

Lasher, William R. (2005). Practical Financial Planning, Fourth Edition. United States: Thomson Southwestern, 636-646.

Financial forecasting methods. An example of the transactions-based approach, presented as an accounting equation is in:

Needles, Belverd, et al, (2002). Principles of Accounting, United States: Houghton-Mifflin, 16-23.

Financing feedback. The iterative technique for solving for debt given financing feedback is presented in:

Brigham, Eugene & L. …