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The owners of a relatlvely small buslness expect slgnlflcant sales growth. They want to estimate how much of the needed funds must be externally financed. The case also raises issues about credit policy.
The owners of a relatlvely small buslness expect slgnlflcant sales growth. They want to estimate how much of the needed funds must be externally financed. The case also raises issues about credit policy.
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The owners of a relatlvely small buslness expect slgnlflcant sales growth. They want to estimate how much of the needed funds must be externally financed. The case also raises issues about credit policy.
Hak Cipta:
Attribution Non-Commercial (BY-NC)
Format Tersedia
Unduh sebagai PDF, TXT atau baca online dari Scribd
Case Abstract " .:/ / , . ":.1 / it " ~ \.' ." . ~ . 1: .. ~ . . it ." ~ . .' . ~ ,;; L The owners of a relatlvely small buslness expect slgnlflcant sales growth and want to estimate how much of the needed funds must be externally financed. The case also raises issues about credit policy. Level of Difficulty Level "1" if question 10 is not assigned. Numerical Uniformity For questions 1-9, only accruals must be estimated. If our estimate is given to the students, then all of these questions have unique numerical answers. Q-10, the credit question, can generate different answers depending on the assumptions used. Suggestions for Reducing the Case's Difficulty Q-10 should probably be omitted. have trouble with 3-a and 5-a. Instructor's Note In addition, students may Topeka (II) can be used independently of this case. The case is a composite of issues faced by two firms that we are familiar with. 75 ANSWERS 1. Davidson is confusing "retained earnings" with "cash on hand." Retained earnings on the balance sheet do not indicate the amount of cash' available to spend. It is best viewed as a "running total" of all profits which have been reinvested in the firm. 2. 1996 Pro Forma IS ($000) Sales Cost of Goods Sold Gross Profit Administrative Costs Depreciation EBIT Interest EBT Taxes(40%) Net Income Here's the rationale for each item. $1,933.1 1,333.8 599.3 441. 7 63.2 94.4 10.0 84.4 33.8 $50.6 3. a. -The sales estimate is given. -Gross profit is predicted to be 31 percent of sales. Note that Shatner's original 32 percent estimate was reduced. , -CGS is sales less gross profit. -Administrative costs are estimated to increase by 20 percent. -Depreciation is $34.0 , the 1995 amount, plus one- sixth of $175, the 1996 predicted spending on plant, land and equipment. -Interest is assumed to remain constant (see case). The overall ACP can be viewed as a weighted average of the average collection period, call it ACP30, of those customers who receive terms of net 30, and the average collection period, ACP45, of those who receive terms of net 45. ACP30 = .80(30) + .20(40) = 32 days ACP45 = .90(45) + .10(55) = 46 days The "overall ACP" equals .40(32) + .60(46) = 40.4 days . ...... l; -. b. Receivables = ($1,933.1/360) * 40.4 = $216.9(000). I 4. 1996 i.e., "ending inventory," is estimated to be $173.2 = $1333.8/7.7 since inventory turnover (CGS/INV) is estimated to be 7.7. 5. 0.-:1 f ,,1 '?' Purchases = CGS + Ending Inventory - Begi7ning Purchases = $1,333.8 + $173.2 - $149.5 Purchases = $1,357.5(000) a. APP = 1/3*10 + 2/3*30 = 23.33 days
b. Accounts Payable = 23.33*($1,357.5/360) = $87.9(000) 6. a. We will need an estimate of accruals. Using the information in Exhibit 1 and Exhibit 2, accruals have averaged 2.2% of sales during the 1993-95 period. ASSETS LIABILITIES & NW Cash $58.0 Accounts Payable $87.9 Receivables 216.9 Accruals 42.5 Inventory 173.2 Debt -Due 20.0 Other Current 11. 6 Total Current $150.4 Total Current $459.7 Gross Fixed 441.1 Long-Term Debt 60.0 (Accumulated Common stock 110.0 depreciation) (188.7) Retained Earnings 215.5 Net Fixed Assets 252.4 Funds Needed 176.2 Total Assets $712.1 Total Lia. &NW $712 .. 1 = = Here's the rationale for each item. -Cash is predicted to be 3 percent of sales. -Receivables were calculated in Q3-b. -Inventory turnover (CGS/inventory) is estimated to be 7.7. Thus the inventory estimate is $1333.8/7.7 = $173.2. -Other current assets are predicted to be .6 percent of sales. -Gross fixed is $266.1 (1995 total) plus $175, the predicted 1996 capital spending. -Accumulated depreciation is $125.5 (1995 total) plUS $63.2, the 1996 amount. -Debt due is given in the case. -Long-term debt is $80, the 1995 amount, less the debt due of $20. -Retained earnings is $164.9 ,the 1995 BS total, plus the estimated 1996 net income of $50.6 (no dividends will be paid) . -Funds needed is the "plug" or balancing item of the forecast. b. The balance sheet indicates that the estimated sources of financing are $176.1(000) short of the projected asset requirements. 77 7. 8. c. Inventory turnover (CGS/INV) was 7.1 in 1993, 7.3 in 1994 and 7.2 in 1995. using this average of 7.2, 1996 inventory is predicted to be $185.3 (=1333.8/7.2). This is $12.1(000) more than estimated above (see 6-a). Thus "funds needed" will be higher but, really, not by a large amount. 1995 assets are 29.6% of sales. Spontaneous liabilities, i.e. , accounts payable and accruals, are 5.3% of sales. The net profit margin is 2.3% and sales are predicted to increase by $386.6(000) in 1996. Since no dividends will be paid, the percent of e.ales method predicts that 1996 funds needed will be $49 .. 4(000), as shown below. " I .,. " {' r. . Funds Needed = - .053)*$386.6 Funds Needed = 93.9 - 44.5 = $49.4(000) r ' i .' ,\. _\ L_ -),1_' \l., ( . :..' The percent of sales method assumes that assets, spontaneous liabilities, and net income are constant percentages of 'sales over the forecasting period. These conditions clearly do not hold here, as Topeka is experiencing significant changes in its working capital and fixed asset requirements. Note that 1996 assets are estimated to be 36.8% of sales and spontaneous liabilities are predicted to be 6.7% of sales. In addition, the percent of sales method does not consider any debt due. So, all things considered, there is no reason to suppose that the estimates in 6-a and 7 will be similar. 9. Let's calculate the retUJrn from taking the discount. Percent return = discount % 100-discount % x _-:--_--=3::..;6:..0:..- _ Final due date- discount period Return % = 2/98 x 360/(30 - 10) = 36.7% By taking the discount, a before-tax return of 36.7 percent is earned. While we don't know Topeka's cost of funds, this strikes us as a very hi9h return relative to current and historical US standards. Taking the discount, therefore, looks like a wise financial move. 10. Note that the relevant choice is between making this sale while granting 45 days 1:0 pay, versus not making the sale and, thus, extending no credit. Asset requirements , 'J J 'i /'1 r',. , . -. l ....I./. . : -!. 11 If p "'If"r; /.1-" The incremental asset requirements, assuming excess capacity, will be the additional investment in receivable:; and, perhaps, inventory. ,/",,'1 = AR*(1-.31) + INV/'", = + $100,000*.69/7.7 = 8,625 + 8,961 = $17,586 Let's first assume that CGS is the only variable cost and equals 69 percent' of 1996 estimate (see Q-2). so, the incremental after-tax profit to Topeka would be $100,000*.31*.6 = $31,000*.6 = $18,600. [ sideooint: Technical accuracy requires that we adjust this for any change in spontaneous liabilities. Now we need to estimate the capital cost of the decision, which depends on the cost of capi.tal for funds tied up in receivables and inventory. This isn't given, but using any "reasonable" figure these costs will be far less than the after-tax profit. For instance, suppose the cost of funds is 20 percent, a figure that is almost surely too high. The capital cost is $17,586*.20 = $3,517. The gain to Topeka from this sale is as follows. Gain = $18,600 - 3,517 = $15,083. with these assumptions, we'd recommend that e'xtend4'5 days of credit rather than lose the sale. We have a "disclaimer," though. rfhe decision to grant this firm an extra 15 days could set a precedent that Topeka won't like. will "giving in" to this customer weaken Topeka'.s bargaining power with other clients? If so, then there are potential "spillover effects" that need to be considered. Now let's assume that Topeka has no excess capacity which implies that the firm's "overhead" must rncrease if the 'salle is made. In Q-2, the 1996 IS indicates that administrative costs are roughly 23 percent of sales. If these costs are proportional to sales, then the incremental after-tax profit is (100,000*.31 - 100,000*.23)*.6 = $4,800. Asset requirements must now consider the increase in fixed assets. In Q-6, the 1996 BS shows that net fixed assets are about 13 percent of sales. Assuming net fixed assets are proportional to sales, Asset requirements = $17,586 + .13*100,000 = $30,586. We previously assumed a 20 percent cost of capital for 79 decisions of this sort. If so, then the capital cost is .20*30,586 = $6,117 and exceeds the expected after-tax profit. Of course, this 20 percent figure is almost surely a "high guesstimate." However, if the cost of funds is above 4,800/30,586 = .16 (which it may be), then granting this firm 45 days to pay is not a good deal even if there are no potential spillover effects. Sidepoint The analysis is relatively simple because we've assumed that Topeka will not get the sale unless it offers terms of net 45. The issue becomes trickier if there is some chance of 'making the sale on terms of net 30. In that case, we must estimate the probability of making the sale on these terms and incorporate this into the analysis.
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