RE: Value of Waterloo Alarm Corp (WAC) Investment
From our visit to WAC and meeting with Julie Marino, we have assessed the following points for analysis as to the company’s worth and how much Julie Marino can be expected to pay for the company.
Other points worth mentioning about WAC include:
- The accountant at WAC does not have any accreditation, which may affect the accuracy and valuation of accounts. Revenue recognition especially does not seem to comply with GAAP standards and thus the net worth of the company may be overstated.
- WAC’s customers are primarily composed of residential owners as opposed to commercial. This may limit the long-term growth potential of the company.
- Rex Sawyer, owner of WAC, has charged various personal expenses as well as provides salary to family members who do not work at the company. He has also stated that he gives out bonuses and dividends in accordance with what he thinks would be beneficial (eg. Staying under the small business limit for tax purposes). This may skew yearly comparability of the financial statements.
We believe the above points and the below analysis will have an impact on the estimated value of WAC we should provide to Julie Marino.[unique_solution]
Space to Rent
A benefit to acquiring this company is that there is another possible source of revenue besides their normal revenue from sales/installation. The building that Waterloo Alarm Corp is based out of is bigger than the amount of space they require. There is approximately 1,100 square feet of unused space that could be rented out at $11 per square foot. If Julia Marino decides to do this, it could be another $12,100 per month of revenue. There may be some costs and time associated with renting the space, like reorganizing the layout and making sure everything is up to standards, but overall this will increase net income.
Tax Liability
There is a possibility that they will be required to pay more taxes if the revenue that had come in from cash is reported. That would be an extra $75,000 which would put them over the $400,000 threshold for 2018. They only reported income for tax purposes as $382,810 and if the total $75,000 was all to be added to that, their total would be $457,810 and $57,810 would be taxed at the higher rate of 38%. There could be a total of $24,890.10 ((400,000 – 382,810 = 17,190*17% = 2,922.30)+(57,810*38% = 21,967.80)) in taxes that may need to be paid. This will also be more when we find out the amount of cash that he deposited personally for 2019.
Contract Analysis
It should be compared the expected revenue per contract and the list of existing contracts, and result the actual revenue for the contract in order to see if there was a difference between estimation and actuation with WAC.
The monitor contract was $510 plus $230 payable and monthly payment for one-year term, and $510 plus $230 payable and plus the monitoring fee for a one or two-year contract paid in advance. And the expected revenue was approximately $100,000 of locksmith sales in 2019 on a cash basis. He also estimated unreported sales for 2018 was $75,000. Comparing the actual monthly payment contracts in the recent two years, the revenue decreased and the number of contracts also decreased from 2018 to 2019. Besides, the prepaid contracts in 2018 were $881,400 with revenue, but the revenue decreased in 2019. The one-year contract increased and there was a large number of two-year contracts decreased sharply. The prices were higher than Rex planned, and the actual revenue was up to his goal. The actual revenue decreased with the year due to reasons of increased fee that compared with estimated price, and the price increased in the second year that made remaining customers couldn’t support and left, and the company either couldn’t attract new customers with high price. The company can think about setting appropriate prices to attract and retain customers.
Financing the Acquisition
The company actually wasn’t much profitable according to the net income, from $928,212 to $209,637 in these two years, the revenue couldn’t cover the expense on operating and manufacturing. What’s more, the current ratio ($1,659,400/$727,120=2.28) in 2018, compared with the current ratio ($1,636,040/$644,123=2.53) in 2019. A high current ratio indicates that WAC is able to meet its short-term obligations. Increases in the current ratio over time may indicate WAC is “growing into” its capacity. Even though its total liability increased, it is still liquidity. The profit ratio in 2018 and 2019, (928,212/1,233,290=0.75 and 209,637/342,575=0.61). The profit ratio decreased a little bit, so WAC had some inefficient management that should be improved.
Because WAC has an operating line of credit calculated as 75% of trade accounts receivable less than 61 days old and 50% inventory. The line of credit is secured by the trade accounts receivable and inventory, plus a personal guarantee of Rex. Thus, Julie can choose credit of line to obtain the business.The loan lets her borrow money up to a pre-set limit. She doesn’t have to use the funds for a specific purpose. And she can pay back the money she owes at any time. She only has to pay interest on the money you borrow. Julie can get funds to buy the business in different ways. Julia would pay a lower interest rate for a line of credit than for a credit card or a personal loan. Depending on the product and financial institution, she may not be charged set-up fees or annual administration fees. To avoid unnecessary fees, if she bank with the same financial institution where she got her line of credit, she may be able to have any overdraft on her chequing account transferred to her line of credit.
External Factors
It is important to consider both industry trends and competitor influences when determining the possible future growth value of WAC.
We have observed that one of WAC’s competitors is offering the alarm system hardware for free upon a five-year contract. This may cut into WAC’s alarm system related sales, which account for more than 50% of WAC’s total revenues for both 2018 and 2019. This may cut down on the future growth that can be expected from the alarm system sales if the competitor is successful. This is an additional cause for concern as the trade magazine “Canadian Lock & Alarm” reports that security monitoring is growing while the market for traditional key locks is declining, possibly decreasing future revenue related to WAC’s other lines of business. This may indicate that the most future growth potential lies in the alarm system market, which may grow more competitive in the near future. This growth in the industry can be an opportunity for WAC, where the competition is a very prominent threat that must be managed if Julie Marino does take over the company.
An important consideration for Julie Marino is if she would be willing to sell the company. “Canadian Lock & Alarm” has indicated that there is a trend in which big players in the alarm system industry buy up local companies at a premium to acquire the territory. This would increase the overall investment value of WAC as they are doing well in the alarm system industry locally.
Conclusion
I want you to complete the conclusion and state what should the fair price of acquisition on above analysis