F0242 - Financial Modeling Laboratory

Exercise - 3
rd
Meeting
1. Littleton Electronics ending cash balance as of January 31, 2010 (the end of its
fscal year 2009 !as "20,000. #ts e$%ected cash collections and %ay&ents for
the ne$t si$ &onths are gi'en in the follo!ing table.
a. (alculate the fr&s e$%ected ending cash balance for each &onth.
b. )ssu&ing that the fr& &ust &aintain an ending cash balance of at least
"20,000, ho! &uch &ust they borro! during each &onth*
c. #f the fr& &ust %ay +, annual interest on its short-ter& borro!ing, ho! does
this a.ect your ending cash balance calculations*
d. /inally, ho! !ould your ending cash balance change of the fr& uses any cash
in e$cess of the &ini&u& to %ay o. its short-ter& borro!ing in each &onth*
2. Lobla! 0anufacturing has as1ed you to create a cash budget in order to
deter&ine its borro!ing needs o'er June to 2ctober %eriod. 3ou ha'e gathered
the follo!ing infor&ation.
Month Sales Other
Payments
June 140,000 50,000
July 130,000 46,000
)ugust 96,000 40,000
7e%te&ber 58,000 86,000
2ctober +4,000 85,000
9o'e&ber
2010
90,000
)%ril and 0ay sales !ere "126,000 and "180,000, res%ecti'ely. :he fr& collects
30, of its sales during the &onth, 40, the follo!ing &onth, and 10, t!o
&onths after the sale. Each &onth it %urchases in'entory e;ual to 46, of the
ne$t &onths e$%ected sales. :he co&%any %ays for 80, of its in'entory
%urchases in the sa&e &onth and 40, in the follo!ing &onth. <o!e'er, the
fr&s su%%liers gi'e it a 2, discount if it %ays during the sa&e &onth as the
%urchase. ) &ini&u& cash balance of "26,000 &ust be &aintained each &onth,
and the fr& %ays 5, annually for short-ter& borro!ing fro& its ban1.
a. (reate a cash budget for June to 2ctober 2010. :he cash budget should
account for short-ter& borro!ing and %aybac1 of outstanding loans. :he fr&
ended 0ay !ith a "30,000 cash balance.
b. =ob Lobla!, the %resident, is considering out its in'entory %ay&ents. <e
belie'es that it &ay be less e$%ensi'e to borro! fro& su%%liers than fro& the
ban1. <e has as1ed you to use the 7cenario 0anager to see !hat the total
interest cost for this ti&e %eriod !ould be if the co&%any %aid for 0,, 10,,
30,, or 80, of its in'entory %urchases in the sa&e &onth. :he balance !ould
be %aid in the follo!ing &onth. (reate a scenario su&&ary and describe
!hether or not the results su%%ort =obs beliefs.
3. <uggins and >ri?n /inancial @lanners ha'e forecasted re'enues for the frst si$
&onths of 2010, as sho!n in the follo!ing table.
Month Reen!e
9o'e&ber
2009
"85,000
Aece&ber 86,000
January 26,000
/ebruary 2+,000
0arch 30,000
)%ril 35,000
0ay 80,000
June 86,000
:he fr& collects 40, of its sales i&&ediately, 39, one &onth after the sale, and
1, are !ritten o. as bad debts t!o &onths after the sale. :he fr& assu&es that
!ages and benefts %aid to clerical %ersonnel !ill be "+,000 %er &onth !hile
co&&issions to sales associates a'erage 26, of collectable sales. Each of the
t!o %artners is %aid "6,000 %er &onth or 20, of net sales, !hiche'er is greater.
(o&&issions and %artner salaries are %aid one &onth after the re'enue is
earned. Bent e$%ense for their o?ce s%ace is "3,600 %er &onth, and lease
e$%ense for o?ce e;ui%&ent is "500. Ctilities a'erage "260 %er &onth, e$ce%t in
0ay and June !hen they a'erage only "160. :he ending cash balance in
Aece&ber 2009 !as "12,000.
a. (reate a cash budget for January to June 2010, and deter&ine the fr&s
ending cash balance in each &onth assu&ing that the %artners !ish to
&aintain a &ini&u& cash balance of "10,000.
b. <uggins and >ri?n are thin1ing of obtaining a line of credit fro& their ban1.
=ased on their e$%ectations for the frst si$ &onths of the year, !hat is the
&ini&u& a&ount that !ould be necessary* Bound your ans!er to the ne$t
highest "1,000 and ignore interest charges on short-ter& debt. (<intD Loo1 u%
the RO"#$"P function in the online hel%.
c. (reate three scenarios (best case, base case, and !orst case assu&ing that
re'enues are 10, better than e$%ected, e$actly as e$%ected, or 10, !orse
than e$%ected. Ehat is the &a$i&u& that the fr& !ould need to borro! its
&ini&u& cash balance in all three cases* Cse the 7cenario 0anager and
create a su&&ary of your results. Eould this change your ans!er in %art b*
8. 3ou !ere recently hired to i&%ro'e the fnancial condition of #daho 7%rings
<ard!are, a s&all chain of three hard!are stores in (olorado. 2n your frst day
the o!ner, (huc1 Fitas1a, told you that the biggest %roble& facing the fr& has
been %eriodic une$%ected cash shortages that ha'e &ade it necessary for hi& to
delay !age %ay&ents to his e&%loyees. <a'ing recently recei'ed a degree in
fnance, you i&&ediately realiGe that your frst %riority is to de'elo% a cash
budget and to arrange for a short-ter& borro!ing agree&ent !ith the fr&s
ban1. )fter loo1ing at the fr&s %ast fnancial records, you de'elo%ed a sales
forecast for the re&ainder of the year, as is %resented in the follo!ing table.
Month Sales
June 2010 "42,000
July +3,000
)ugust +4,000
7e%te&ber +0,000
2ctober 69,000
9o'e&ber 8+,000
Aece&ber 81,000
#n addition to the seasonality of sales, you ha'e obser'ed se'eral other %atterns.
#ndi'iduals account for 80, of the fr&s sales, and they %ay in cash. :he other
40, of sales are to contractors !ith credit accounts, and they ha'e u% to 40 days
to %ay. )s a result, about 20, of sales to contractors are %aid one &onth after
the sale, and the other 50, is %aid t!o &onths after the sale. Each &onth the
fr& %urchases in'entory e;ual to about 86, of the follo!ing &onths sales.
)bout 30, of this in'entory is %aid for in the &onth of deli'ery, !hile the
re&aining +0, is %aid one &onth later.
Each &onth the co&%any %ays its hourly e&%loyees a total of "9,000, including
benefts. #ts salaried e&%loyees are %aid "12,000, also including benefts. #n the
%ast, the co&%any had to borro! to build its stores and for the initial in'entories.
:his debt has resulted in &onthly interest %ay&ents of "8,000 and &onthly
%rinci%al %ay&ents of "221. 2n a'erage, &aintenance at the stores is e$%ected
to cost about "+00 %er &onth, e$ce%t in the 2ctober to Aece&ber %eriod !hen
sno! re&o'al costs !ill add about "200 %er &onth. 7ales ta$es are +, of
;uarterly sales and &ust be %aid in June, 7e%te&ber, and Aece&ber. 2ther ta$es
are also %aid during those &onths and are e$%ected to be about 8, of ;uarterly
sales in each of those &onths. :he o!ner !ishes to &aintain a cash balance of at
least "12,000 to li&it the ris1 of cash shortages. :he cash balance at the end of
0ay is e$%ected to be "16,000 (before any borro!ing or in'esting.
a. (reate a si&%le cash budget for #daho 7%rings <ard!are for June to Aece&ber.
9ote that your records indicate that sales in )%ril and 0ay !ere "61,000 and
"6+,000, res%ecti'ely. January 2011 sales are e$%ected to be "34,000. Ehat
!ould be the ending cash balances if the fr& does not borro! to &aintain its
"12,000 &ini&u&*
b. 9o! assu&e that the fr& can borro! fro& the ban1 at a rate of 9, %er annu&
to &aintain its li;uidity and &eet its re;uired &ini&u& cash balance, in
addition, if the fr& has funds in e$cess of the &ini&u&, it !ill use the e$cess
to %ay o. any %re'ious balance.
c. Ehile negotiating a line of credit, the fr&s ban1 o.ered to s!ee% any cash in
e$cess of the &ini&u& into a &oney &ar1et fund that !ill return an a'erage
of 8, %er year after e$%enses. #f you acce%t this o.er, ho! !ill it a.ect the
fr&s ending cash balances and need to borro! in each &onth* 9ote that the
fr& &ust ha'e %aid o. all short-ter& loans before any e$cess cash can be
in'ested, and in'ested funds !ill be used instead of borro!ing !hen needed.
d. )fter co&%leting the cash budget, you begin to thin1 of !ays to further reduce
the fr&s borro!ing needs. 2ne idea that co&es to &ind is changing the fr&s
credit %olicy !ith contractors because they see& to al!ays %ay at the last
&inute. :hree scenarios co&e to &indD (1 #n the best case, contractors are
re;uired to %ay for 100, of the &onth after the sale. 3ou belie'e that this
!ould cause a 6, decline in sales. (2 #n the base case, e'erything re&ains as
already outlined. (3 #n the !orst case, contractors !ould be re;uired to %ay for
100, of their %urchases during the &onth after the sale, and you belie'e that
this !ould cause a 20, dro% in sales. 3ou decide to use the 7cenario 0anager
to e'aluate these scenarios. :o su&&ariGe the i&%act of the change, you !ill
e$a&ine the i&%act on the fr&s &a$i&u& borro!ing needs and cu&ulati'e
net interest cost (after accounting for in'est&ent earnings. #n your o%inion,
should the fr& change its credit %olicy*