CAPSTONE CASE 1: ECO-PRODUCTS, INC.
End-of-Case Assignments: Suggested Discussions and Analyses
A. Describe Eco-Products’ early history (1990 through 2003). Would you view the firm
during that period as being a life-style business, an entrepreneurial venture, or? Why?
Steve Savage and his father founded the company in 1990 with the intent to provide eco–
B. Discuss Eco-Products’ revenue growth–based “business model” that evolved over the
2004 through early 2008 period in terms of (a) production versus distribution, (b)
product line development, (c) branding, etc.
The company remained a local marketer of green janitorial paper and building supplies
a) In 2004-05 Eco-Products remained primarily a distributor of eco-friendly
b) Steve Savage emphasized the development of a signature Eco-Products line from
c) As wholesale distribution grew, existing product manufacturers restricted Eco-
C. What is the size of the domestic and global markets for foodservice disposable
packaging? Who are the major competitors producing/selling environmentally-friendly
food service products. What intellectual property or competitive advantages does Eco-
Products, Inc. possess?
Capstone Case 1: Eco-Products, Inc.
The global food service disposable industry produces an estimated $30 billion in sales
annually. Biodegradable products represented the fastest growing segment of the
D. Exhibits 2 and 3 present Eco-Products’ financial statement information for 2005, 2006,
and 2007. Prepare a ratio analysis of the firm’s financial performance over the 2005-07
period.
Note: the financial statements for 2005 and 2006 were unaudited. For 2007, the
income statement and statement of cash flow were “reviewed” while the balance
Note: we are using end-of-year balance sheet items (rather than averages) in order to
have three comparison years and to recognize that the firm’s business model (from a
retailer of products manufactured by others to a manufacturer/wholesaler of eco-friendly
products.
Capstone Case 1: Eco-Products, Inc.
2005 Total Debt to Total Assets = 435,696/795,465 = .548 = 54.8%
As Eco-products moved from being a distributor/retailer of other manufacturers’ products
to producing/wholesaling its own products, its profit margins declined from 2005 to
2007. In fact, the firm had a net loss in 2007 due in large part to the nearly $200,000
(actually $186,726) in interest expense associated with the obtaining of a line of credit
which was $2,843,242 at the end of December, 2007. As sales “ramp up” in the future, it
is important to “spread” the “fixed” and “semi–fixed” operating expenses in order to
improve the operating profit margin and the firm’s value.
An accompanying Excel spreadsheet provides the following ratio calculations for
2007 and 2008 (data were not available until 2009).
Selected Ratios: 2007 2008
GOGS/Revenues 71.1% 75.7%
Gross Profit Margin 28.9% 24.3%
Operating Profit Margin 1.2% 3.2%
Net Profit Margin –0.3% 1.6%
Sales or Revenues/Total Assets 1.924 1.819
Return on Assets –0.6% 2.8%
Total Debt to Total Assets 72.8% 71.2%
Return on Equity –2.4% 9.9%
E. Exhibit 4 presents Eco-Products’ Statement of Cash Flows for 2007. Was the firm
building or burning cash in its operating activities? When also considering cash flows
from investing activities, was Eco Products in a net cash build or burn position in 2007?
for 2007. While many of the changes in balance sheet accounts between 2006 and 2007
match with the amounts presented in the consolidated statements of cash flow in Exhibit
4, others do not. Thus, for this question we suggest that students concentrate on Exhibit 4
to determine the extent to which Eco-Products was building or burning cash in 2007.
In Chapter 4 we presented a short method for determining whether a firm had been
building or burning cash. The short method sums the net cash used in operating activities
and the net cash used in investing activities.
2007 Cash Build/Burn = net cash used in operating activities + net cash used in investing
A more detailed method for estimating cash build or burn was provided in Chapter 5.
Note: there may be deferred income taxes as well as changes in other less common
current asset and current liability accounts (as shown in Exhibit 4) that must be accounted
for in determining net cash used in operating activities. These include prepaid expenses
and other assets, income tax receivable, deposits, other current liabilities, deferred lease
liability, and deferred revenue and are considered below.
Capstone Case 1: Eco-Products, Inc.
F. Describe the early rounds of financing that occurred from Eco-Products’ inception in
1990 through 2006. Beginning in 2007, the need for external financing began
increasing. Describe the sources, amounts, and types of financing obtained during
2007and the early part of 2008.
Exhibit 5 in the case summarizes previous rounds of financing. Eco-Products was started
with $8,000 in seed money in 1990. Additional equity investments from the founders,
G. In mid-2007, Eco-Products’ management prepared a five-year (2007-2011) projection of
revenues and expenses (see Exhibit 1). What annual rates of growth were projected for
net sales? Make a “back-of-the-envelope” estimate of the amounts of additional assets
needed to support the sales forecasts. How might these assets be financed? Prepare a
“rough” estimate of the possible size of external financing needed to support these sales
projections.
First, let’s review recent actual sales growth rates:
Year Sales/Revenues Percent Increase
Financial Projections (made in mid-2007) in Thousands of Dollars:
Change
Capstone Case 1: Eco-Products, Inc.
Actual revenues for 2006 were 5,751,787 or in Thousands of Dollars rounded to 5,752.
The five-year compound rate of growth between 2006 actual revenues and projected 2011
revenues of 78,000 is:
Over the 2005-2007 period, Eco-Products changed from being primarily a retail
distributor of eco-friendly paper and plastic products produced by other manufacturers to
a wholesale distributor of its own “branded” eco-friendly products. If we assume that the
sales to assets relationship that existed at the end of 2007 would hold going forward, we
have:
Using the actual 2007 revenues, we have the following estimates for the change in both
sales and assets:
Change Assets/ Change
Year Sales/Revenues in Sale x Sales = in Assets
Based, on these estimates, Eco-Products will need to acquire nearly $6 million in assets
in 2008 and nearly $35 million over the 2008-2011 period. Recently 2008 sales forecasts
Capstone Case 1: Eco-Products, Inc.
In Chapter 6, we introduced a basic additional funds needed (AFN) equation which can
provide a quick “back-of-the-envelope” estimate of future external financing needs.
AFN = (Total Assets/Sales)(Change in Sales) – (Accounts Payable + Accrued
Liabilities)/(Change in Sales) – (Next Year’s Sales)(Net Income/Net Sales)(Retention
Rate)
Note: Eco-Products must return to profitability in order to finance its sales growth and to
add to firm value. Exhibit 1 projects an EBITDA/Sales margin of 8.5%. A net profit
margin of 4.25% (8.5% x .50) might be achievable and is used here for illustrative
purposes. A 100% retention rate also is assumed.
Two AFN estimates are prepared for 2008:
1) 2008 AFN for Sales of $22,000 = .520(11,133) – .052(11,133) –
The 2008 AFN ranges from $4.275 million for $22 million in sales to $14.061 million for
$45 million in sales or revenues.
The large AFN estimates are due in large part to working capital needs primarily in the
form of higher accounts receivable and inventory. The amount of funds tied up in
Capstone Case 1: Eco-Products, Inc.
Eco-Products, Inc.
Financial Statements and Projections Forecast Basis: Mid-2007 Moderate Early-2008
[Dollars] Actual Percent of Forecast Forecast Forecast
Income Statements 2007
2007 Revenues (Sales)
2008 2008 2008
Net Revenues 10,867,104 Estimated Amounts 22,000,000 35,000,000 45,000,000
Cost of Goods Sold 7,726,455 0.711 x sales forecast 15,642,000 24,885,000 31,995,000
Gross Profit 3,140,649 6,358,000 10,115,000 13,005,000
Operating Expenses
Bad Debt 141 0.000 x sales forecast 0 0 0
Depreciation and Amortization 87,563 0.008 x sales forecast 176,000 280,000 360,000
Employee Benefits 114,011 0.010 x sales forecast 220,000 350,000 450,000
General and Administrative 494,061 0.045 x sales forecast 990,000 1,575,000 2,025,000
Payroll Taxes 117,557 0.011 x sales forecast 242,000 385,000 495,000
Occupancy Expense 349,668 0.032 x sales forecast 704,000 1,120,000 1,440,000
Repairs and Maintenance 27,140 0.002 x sales forecast 44,000 70,000 90,000
Salaries and Wages 1,778,282 *0.123 x sales forecast 2,706,000 4,305,000 5,535,000
Selling and Marketing Expenses 43,783 *0.016 x sales forecast 352,000 560,000 720,000
Total Operating Expenses 3,012,206 5,434,000 8,645,000 11,115,000
Operating Profit 128,443 924,000 1,470,000 1,890,000
Other Income and (Expenses)
Interest Expense -186,726 *(0.009) x sales forecast (198,000) (315,000) (405,000)
Other Income 0 0.000 x sales forecast – – –
Other Expense -1,192 (0.001) x sales forecast (22,000) (35,000) (45,000)
Net Other Income & (Expenses) -187,918 –220,000 -350,000 -450,000
Net Income (Loss) Before Taxes -59,475 704,000 1,120,000 1,440,000
Provision for Income Taxes
Estimated Taxes *Assumes 35% Tax Rate (246,400) (392,000) (504,000)
Current Tax Benefit 52,276
Deferred Tax Expense -29,000
Total Provision of Income Taxes 23,276 -246,400 –392,000 -504,000
Net Income (Loss) -36,199 457,600 728,000 936,000
Balance Sheets Actual Percent Forecast Forecast Forecast
Assets 2007 of Sales 2008 2008 2008
Current Assets
Cash 51,667 0.5% 0.005 x sales forecast 104,598 166,405 213,950
Accounts Receivable, Net 1,330,562 12.2% 0.122 x sales forecast 2,684,000 4,270,000 5,490,000
Prepaid Expenses & Other Cur. Assets 728,776 6.7% 0.067 x sales forecast 1,474,000 2,345,000 3,015,000
Income Tax Receivable 54,506 0.5% 0.005 x sales forecast 110,000 175,000 225,000
Inventory 2,415,916 22.2% 0.222 x sales forecast 4,884,000 7,770,000 9,990,000
Deferred Income Tax Asset 42,000 0.4% Held Constant 42,000 42,000 42,000
Total Current Assets 4,623,427 42.5% 9,298,598 14,768,405 18,975,950
Property and Equipment
Total Assets 5,647,015 52.0% 10,684,598 16,973,405 21,810,950
Actual Percent Forecast Forecast Forecast
Liabilities and Equity 2007 of Sales 2008 2008 2008
Current Liabilities
Accounts Payable & Accrued Expenses 568,131 5.2% 0.052 x sales forecast 1,144,000 1,820,000 2,340,000
Accrued Payroll & Payroll Taxes 6,712 0.1% 0.001 x sales forecast 22,000 35,000 45,000
Accrued Vacation 39,865 0.4% 0.004 x sales forecast 88,000 140,000 180,000
Lines of Credit 2,843,242 26.2% *0.262 x sales forecast 5,764,000 9,170,000 11,790,000
Current Portion of Long-Term Debt 39,356 0.4% 0.004 x sales forecast 88,000 140,000 180,000
Current Portion of Capital Leases 37,919 0.3% 0.003 x sales forecast 66,000 105,000 135,000
Deferred Revenue 105,588 1.0% Held Constant 105,588 105,588 105,588
Loan from Stockholder 93,394 0.9% Held Constant 93,394 93,394 93,394
Other Current Liabilities 21,523 0.2% 0.002 x sales forecast 44,000 70,000 90,000
Total Current Liabilities 3,755,730 34.6% 7,414,982 11,678,982 14,958,982
Deferred Income Tax Liability 54,000 0.5% 0.005 x sales forecast 110,000 175,000 225,000
Deferred Lease Liability 36,383 0.3% 0.052 x sales forecast 66,000 105,000 135,000
Long-Term Capital Leases, Net of Current Por. 141,228 1.3% Held Constant 141,228 141,228 141,228
Long-term Debt, Net of Current Portion 124,546 1.1% Held Constant 124,546 124,546 124,546
Total Liabilities 4,111,887 37.8% 7,856,756 12,224,756 15,584,756
Stockholders’ Equity
Common Stock, $.001 Par Value
50,000,000 Shares Authorized
16,935,000 Shares Issued & Outstanding 156,300 1.4% Held Constant 156,300 156,300 156,300
Preferred Stock, $.001 Par Value
1,750,000 Shares Authorized
1,366,666 Shares Issued & Outstanding 0 Held Constant 0 0 0
Additional Paid-In-Capital 1,269,908 11.7% Held Constant 1,269,908 1,269,908 1,269,908
Retained Earnings 108,920 1.0% [+2008 Net Income] 566,520 836,920 1,044,920
Total Stockholders’ Equity 1,535,128 14.1% 1,992,728 2,263,128 2,471,128
*Additional Financing Needed 0 835,114 2,485,521 3,755,066
Total Liabilities & Stockholders’ Equity 5,647,015 52.0% 10,684,598 16,973,405 21,810,950
Notes on Projected Financial Statements
Income Statement:
*Salaries and Wages--reduced by 25% from the 16.4% 2007 relationship to reflect expected economies
*Selling and Marketing Expenses--increased 4 times the .4% 2007 relationship to reflect the need for higher expenditures
*Interest Expense was projected at one-half the 2007 percent of sales rate due to a likely slower growth rate for interest-bearing debt
*Additional Financing Needed is the amount of long-term debt and equity funds needed to finance projected sales growth
(PPM) dated October 16, 2007 in an attempt to raise $3,500,000. Appendix A contains
excerpts from the PPM.
1. What is meant by a Regulation D offering? What is an accredited investor and how
many investors can participate in the PPM? [You may wish to review materials from
2. Considering the planned use of proceeds, discuss the pros and cons of trying to raise
$3,500,000 in increments as small as $50,000 each.
A $3.5 million private placement memorandum fall under Reg D: Rule 505 which has
a $5 million offering limit in a 12-month period. While there is no limit on the
number of accredited investors, there is a limit of 35 unaccredited investors. At the
3. Summarize the risk factors listed by management in the Private Placement
Memorandum. Which factors do you believe are the most crucial in determining the
future success of Eco-Products?
Appendix A provides excerpts for Eco-Products 2007 Private Placement
Memorandum. Risk factors include:
Supply chain-related risks (availability to obtain raw materials and reliance on importing
products from overseas suppliers), the need for new product development, and increasing
I. Identify and discuss the factors and developments that led to the previously unexpected
revenue growth during the first-half of 2008 by Eco-Products. Is such growth likely to be
sustainable in the near future? What possible developments might interrupt or change
this rapid rate of sales growth?
In mid-2007, management forecasted full-year 2007 sales to be $9.2 million with a sales
forecast of $22 million for 2008 (refer to Exhibit 1). Then, the “perfect storm” hit. Oil