Chapter 4

Discussion Questions

4-1. What are the basic benefits and purposes of developing pro forma statements and a cash budget?

The pro-forma financial statements and cash budget enable the firm to determine its future level of asset needs and the associated financing that will be required. Furthermore, one can track actual events against the projections. Bankers and other lenders also use these financial statements as a guide in credit decisions.

4-2. Explain how the collections and purchases schedules are related to the borrowing needs of the corporation.

The collections and purchase schedules measure the speed at which receivables are collected and purchases are paid. To the extent collections do not cover purchasing costs and other financial requirements, the firm must look to borrowing to cover the deficit.

4-3. With inflation, what are the implications of using LIFO and FIFO inventory methods? How do they affect the cost of goods sold?

LIFO inventory valuation assumes the latest purchased inventory becomes part of the cost of goods sold, while the FIFO method assigns inventory items that were purchased first to the cost of goods sold. In an inflationary environment, the LIFO method will result in a higher cost of goods sold figure and one that more accurately matches the sales dollars recorded at current dollars.

4-4. Explain the relationship between inventory turnover and purchasing needs.

The more rapid the turnover of inventory, the greater the need for purchase and replacement. Rapidly turning inventory makes for somewhat greater ease in foreseeing future requirements and reduces the cost of carrying inventory.

4-5. Rapid corporate growth in sales and profits can cause financing problems. Elaborate on this statement.

Rapid growth in sales and profits is often associated with rapid growth in asset commitment. A $100,000 increase in sales may cause a $50,000 increase in assets, with perhaps only $10,000 of the new financing coming from profits. It is very seldom that incremental profits from sales expansion can meet new financing needs.

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4-6. Discuss the advantage and disadvantage of level production schedules in firms with cyclical sales.

Level production in a cyclical industry has the advantage of allowing for the maintenance of a stable work force and reducing inefficiencies caused by shutting down production during slow periods and accelerating work during crash production periods. A major drawback is that a large stock of inventory may be accumulated during the slow sales period. This inventory may be expensive to finance, with an associated danger of obsolescence.

4-7. What conditions would help make a percent-of-sales forecast almost as accurate as pro forma financial statements and cash budgets?

The percent-of-sales forecast is only as good as the functional relationship of assets and liabilities to sales. To the extent that past relationships accurately depict the future, the percent-of-sales method will give values that reasonably represent the values derived through the pro-forma statements and the cash budget.

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Chapter 4Problems1. Eli Lilly is very excited because sales for his nursery and plant company are expected to

double from $600,000 to $1,200,000 next year. Eli notes that net assets (Assets — Liabilities) will remain at 50 percent of sales. His firm will enjoy an 8 percent return on total sales. He will start the year with $120,000 in the bank and is bragging about the Jaguar and luxury townhouse he will buy. Does his optimistic outlook for his cash position appear to be correct? Compute his likely cash balance or deficit for the end of the year. Start with beginning cash and subtract the asset buildup (equal to 50 percent of the sales increase) and add in profit.

4-1. Solution:

Eli Lilly

Beginning cash $120,000– Asset buildup (300,000) (1/2 × $600,000)Profit 96,000 (8% × $1,200,000)Ending cash ($84,000) Deficit

No, he will actually end up with a negative cash balance.

2. In problem 1 if there had been no increase in sales and all other facts were the same, what would Eli’s ending cash balance be? What lesson do the examples in problems 1 and 2 illustrate?

4-2. Solution:

Eli Lilly (continued)

Beginning cash $120,000No asset buildup -----Profit 48,000 (8% × $600,000)Ending cash $168,000

The lesson to be learned is that increased sales can increase the financing requirements and reduce cash even for a profitable firm.

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3. Gibson Manufacturing Corp. expects to sell the following number of units of steel cables at the prices indicated under three different scenarios in the economy. The probability of each outcome is indicated. What is the expected value of the total sales projection?

Outcome Probability Units PriceA 0.20 100 $20B 0.50 180 25C 0.30 210 30

4-3. Solution:

Gibson Manufacturing Corporation

(1) (2) (3) (4) (5) (6)

Outcome Probability Units PriceTotalValue

ExpectedValue(2 × 5)

A .20 100 $20 2,000 400B .50 180 $25 4,500 2,250C .30 210 $30 6,300 1,890

Total expected value $4,540

4. The Alliance Corp. expects to sell the following number of units of copper cables at the prices indicated, under three different scenarios in the economy. The probability of each outcome is indicated. What is the expected value of the total sales projection?

Outcome Probability Units PriceA 0.30 200 $15B 0.50 320 30C 0.20 410 40

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4-4. Solution:

Alliance Corporation

(1) (2) (3) (4) (5) (6)Expected

Total ValueOutcome Probability Units Price Value (2 × 5)

A .30 200 $15 $3,000 900B .50 320 $30 9,600 4,800C .20 410 $40 16,400 3,280

Total expected value $8,980

5. ER Medical Supplies had sales of 2,000 units at $160 per unit last year. The marketing manager projects a 25 percent increase in unit volume this year with a 10 percent price increase. Returned merchandise will represent 5 percent of total sales. What is your net dollar sales projection for this year?

4-5. Solution:

ER Medical Supplies

Unit volume 2,000 × 1.25............................................. 2,500Price $160 × 1.10.............................................. $176Total Sales........................................................................$440,000Returns (6%).................................................................... 22,000Net Sales..........................................................................$418,000

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6. Cyber Security Systems had sales of 3,000 units at $50 per unit last year. The marketing manager projects a 20 percent increase in unit volume sales this year with a 10 percent price increase. Returned merchandise will represent 6 percent of total sales. What is your net dollar sales projection for this year?

4-6. Solution:

Cyber Security Systems

Unit volume 3,000 × 1.20.................. 3,600Price $50 × 1.10..................... × $55Total Sales............................................. $198,000Returns (6%)......................................... 11,880Net Sales............................................... $186,120

7. Sales for Ross Pro’s Sports Equipment are expected to be 4,800 units for the coming month. The company likes to maintain 10 percent of unit sales for each month in ending inventory. Beginning inventory is 300 units. How many units should the firm produce for the coming month?

4-7. Solution:

Ross Pro’s Sports Equipment

+ Projected sales.................... 4,800 units+ Desired ending inventory... 480 (10% × 4,800)– Beginning inventory........... 300

Units to be produced.......... 4,980

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8. Digitex, Inc., had sales of 6,000 units in March. A 50 percent increase is expected in April. The company will maintain 5 percent of expected unit sales for April in ending inventory. Beginning inventory for April was 200 units. How many units should the company produce in April?

4-8. Solution:

Digitex, Inc.

+ Projected sales............. 9,000 units (6,000 × 1.5)+ Desired ending inventory 450 units (5% × 9,000)– Beginning inventory.... 200 units

Units to be produced.... 9,250 units

9. Hoover Electronics has beginning inventory of 22,000 units, will sell 60,000 units for the coming month, and desires to reduce ending inventory to 30 percent of beginning inventory. How many units should Hoover produce?

4-9. Solution:

Hoover Electronics

+ Projected sales.................... 60,000 units+ Desired ending inventory... 6,600 (30% × 22,000)– Beginning inventory........... 22,000 units

Units to be produced.......... 44,600 units

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10. On December 31 of last year, Barton Air Filters had in inventory 600 units of its product, which costs $28 per unit to produce. During January, the company produced 1,200 units at a cost of $32 per unit. Assuming Barton Air Filters sold 1,500 units in January, what was the cost of goods sold (assume FIFO inventory accounting)?

4-10. Solution:

Barton Air Filters

Cost of goods sold on 1,500 units

Old inventory: Quantity (Units)...................................... 600 Cost per unit............................................ $ 28 Total........................................................ $ 16,800

New inventory: Quantity (Units)...................................... 900 Cost per unit............................................ $ 32 Total $28,800Total Cost of Goods Sold......................... $45,600

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11. On December 31 of last year, Wolfson Corporation had in inventory 400 units of its product, which cost $21 per unit to produce. During January, the company produced 800 units at a cost of $24 per unit. Assuming that Wolfson Corporation sold 700 units in January, what was the cost of goods sold (assume FIFO inventory accounting)?

4-11. Solution:

Wolfson Corporation

Cost of goods sold on 700 units

Old inventory: Quantity (Units)...................................... 400 Cost per unit............................................ $ 21 Total........................................................ $ 8,400

New inventory: Quantity (Units)...................................... 300 Cost per unit............................................ $ 24 Total $ 7,200Total Cost of Goods Sold......................... $15,600

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12. At the end of January, Lemon Auto Parts had an inventory of 825 units, which cost $12 per unit to produce. During February the company produced 750 units at a cost of $16 per unit. If the firm sold 1,050 units in February, what was its cost of goods sold?a. Assume LIFO inventory accounting.b. Assume FIFO inventory accounting.

4-12. Solution:

Lemon Auto Partsa. LIFO Accounting

Cost of goods sold on 1,050 unitsNew inventory: Quantity (Units)...................................... 750 Cost per unit............................................ $ 16 Total........................................................ $12,000Old inventory: Quantity (Units)...................................... 300 Cost per unit............................................ $ 12 Total $ 3,600Total Cost of Goods Sold......................... $15,600

b. FIFO Accounting

Cost of goods sold on 1,050 unitsOld inventory: Quantity (Units)...................................... 825 Cost per unit............................................ $ 12 Total........................................................ $ 9,900New inventory: Quantity (Units)...................................... 225 Cost per unit............................................ $ 16 Total $ 3,600Total Cost of Goods Sold......................... $13,500

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13. Convex Mechanical Supplies produces a product with the following costs as of July 1, 2009:

Material $ 6Labor 4Overhead 2

$12

Beginning inventory at these costs on July 1 was 5,000 units. From July 1 to December 1, Convex produced 15,000 units. These units had a material cost of $10 per unit. The costs for labor and overhead were the same. Convex uses FIFO inventory accounting.

Assuming that Convex sold 17,000 units during the last six months of the year at $20 each, what would gross profit be? What is the value of ending inventory?

4-13. Solution:

Convex Mechanical Supplies

Sales (17,000 @ $20) $340,000Cost of goods sold:Old inventory: Quantity (units).................. 5,000 Cost per unit....................... $ 12Total..................................... $ 60,000New inventory: Quantity (units).................. 12,000 Cost per unit....................... $ 16Total..................................... $192,000Total cost of goods sold..................................... $252,000Gross profit.......................... $ 88,000

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4-13. (Continued)

Value of ending inventory:Beginning inventory (5,000 $12)..................... $ 60,000+ Total production (15,000 $16)................... $240,000Total inventory available for sale................ $300,000– Cost of good sold.............. $252,000Ending inventory.................. $ 48,000

Or3,000 units $16 = $48,000

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14. Assume in problem 13 that Convex used LIFO accounting instead of FIFO. What would gross profit be? What is the value of ending inventory?

4-14. Solution:Convex Mechanical Supplies (Continued)

Sales (17,000 @ $20) $340,000Cost of goods sold:New inventory: Quantity (units).................. 15,000 Cost per unit....................... $ 16Total..................................... $240,000Old inventory: Quantity (units).................. 2,000 Cost per unit....................... $ 12Total..................................... $ 24,000Total cost of goods sold..................................... $264,000Gross profit.......................... $ 76,000

Value of ending inventory:Beginning inventory (5,000 $12)..................... $ 60,000

+ Total production (15,000 $16)................... $240,000Total inventory available for sale................ $300,000

– Cost of good sold................. $264,000Ending inventory.................. $ 36,000

OR3,000 units $12 = $36,000

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15. Jerrico Wallboard Co. had a beginning inventory of 7,000 units on January 1, 2008.The costs associated with the inventory were:

Material.......................... $9.00 unitLabor.............................. 5.00 unitOverhead........................ 4.10 unit

During 2008, Jerrico produced 28,500 units with the following costs:

Material.......................... $11.50 unitLabor.............................. 4.80 unitOverhead........................ 6.20 unit

Sales for the year were 31,500 units at $29.60 each. Jerrico uses LIFO accounting. What was the gross profit? What was the value of ending inventory?

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4-15. Solution:

Jerrico Wallboard Co.

Sales (31,500 @ $29.60) $932,400Cost of goods sold:New inventory: Quantity (units).................. 28,500 Cost per unit....................... $ 22.50Total..................................... $641,250Old inventory: Quantity (units).................. 3,000 Cost per unit....................... $ 18.10Total..................................... $ 54,300Total cost of goods sold..................................... $695,550Gross profit.......................... $236,850

Value of ending inventory:Beginning inventory (7,000 $18.10)............... $126,700+ Total production (28,500 $22.50)...........

$641,250

Total inventory available for sale................ $767,950– Cost of good sold.............. $695,550Ending inventory................. $ 72,400

OR4,000 units $18.10 = $72,400

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16. J. Lo’s Clothiers has forecast credit sales for the fourth quarter of the year as:

September (actual)............................. $70,000Fourth Quarter

October.............................................. $60,000November.......................................... 55,000December.......................................... 80,000

Experience has shown that 30 percent of sales are collected in the month of sale, 60 percent in the following month, and 10 percent are never collected.

Prepare a schedule of cash receipts for J. Lo’s Clothiers covering the fourth quarter (October through December).

4-16. Solution:

J. Lo’s Clothiers

September October November DecemberCredit sales $70,000 $60,000 $55,000 $80,00030% Collected in month of sales

18,000 16,500 24,000

60% Collected in month after sales

42,000 36,000 33,000

Total cash receipts $60,000 $52,500 $57,000

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17. Victoria’s Apparel has forecast credit sales for the fourth quarter of the year as:

September (actual)............................. $50,000Fourth Quarter

October.............................................. $40,000November.......................................... 35,000December.......................................... 60,000

Experience has shown that 20 percent of sales are collected in the month of sale, 70 percent in the following month, and 10 percent are never collected.

Prepare a schedule of cash receipts for Victoria’s Apparel covering the fourth quarter (October through December).

4-17. Solution:

Victoria’s Apparel

September October November DecemberCredit sales $50,000 $40,000 $35,000 $60,00020% Collected in month of sales

8,000 7,000 12,000

70% Collected in month after sales

35,000 28,000 24,500

Total cash receipts $43,000 $35,000 $36,500

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18. Pirate Video Company has made the following sales projections for the next six months. All sales are credit sales.

March $24,000 June $28,000April 30,000 July 35,000May 18,000 August 38,000

Sales in January and February were $27,000 and $26,000, respectively.Experience has shown that of total sales, 10 percent are uncollectible, 30 percent are

collected in the month of sale, 40 percent are collected in the following month, and 20 percent are collected two months after sale.

Prepare a monthly cash receipts schedule for the firm for March through August.Of the sales expected to be made during the six months from March through August,

how much will still be uncollected at the end of August? How much of this is expected to be collected later?

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4-18. Solution:Pirate Video Company

Cash Receipts Schedule

January February March April May June July AugustSales $27,000 $26,000 $24,000 $30,000 $18,000 $28,000 $35,000 $38,000Collections(30% of current sales) 7,200 9,000 5,400 8,400 10,500 11,400Collections(40% of prior month’s sales) 10,400 9,600 12,000 7,200 11,200 14,000Collections(20% of sales 2 months earlier) 5,400 5,200 4,800 6,000 3,600 5,600Total cash receipts $23,000 $23,800 $22,200 $21,600 $25,300 $31,000Still due (uncollected) in August:Bad debts: ($24,000 + 30,000 + 18,000 + 28,000 + 35,000 + 38,000) × .1 = (173,000) × .1 = $17,300To be collected from August sales: ($38,000 × .60) = $22,800To be collected from July sales: ($35,000 × .20) = $7,000$17,300 + $22,800 + $7,000 = $47,100 dueExpected to be collected: $47,100 due – $17,300 bad debts = $29,800 to be collected

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19. The Elliot Corporation has forecast the following sales for the first seven months of the year:

January $12,000 May $12,000February 16,000 June 20,000March 18,000 July 22,000April 24,000

Monthly material purchases are set equal to 20 percent of forecasted sales for the next month. Of the total material costs, 40 percent are paid in the month of purchase and 60 percent in the following month. Labor costs will run $6,000 per month, and fixed overhead is $3,000 per month. Interest payments on the debt will be $4,500 for both March and June. Finally, Elliot’s salesforce will receive a 3 percent commission on total sales for the first six months of the year, to be paid on June 30.

Prepare a monthly summary of cash payments for the six-month period from January through June. (Note: Compute prior December purchases to help get total material payments for January.)

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4-19. Solution:Elliot Corporation

Cash Payments ScheduleDec. Jan. Feb. March April May June July

Sales $12,000 $16,000 $18,000 $24,000 $12,000 $20,000 $22,000Purchases (20% of next month’s sales) 2,400 3,200 3,600 4,800 2,400 4,000 4,400Payment (40% of current purchases) 1,280 1,440 1,920 960 1,600 1,760Material payment (60% of previous month’s purchases)

1,440 1,920 2,160 2,880 1,440 2,400

Total payment for materials 2,720 3,360 4,080 3,840 3,040 4,160Labor costs 6,000 6,000 6,000 6,000 6,000 6,000Fixed overhead 3,000 3,000 3,000 3,000 3,000 3,000Interest payments 4,500 4,500Sales commission (3% of $102,000)

3,060

Total payments $ 11,720 $12,360 $17,580 $12,840 $12,040 $20,720

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20. Wright Lighting Fixtures forecasts its sales in units for the next four months as follows:

March 4,000April 10,000May 8,000June 6,000

Wright maintains an ending inventory for each month in the amount of one and one-half times the expected sales in the following month. The ending inventory for February (March’s beginning inventory) reflects this policy. Materials cost $7 per unit and are paid for in the month after production. Labor cost is $3 per unit and is paid for in the month incurred. Fixed overhead is $10,000 per month. Dividends of $14,000 are to be paid in May. Eight thousand units were produced in February.

Complete a production schedule and a summary of cash payments for March, April, and May. Remember that production in any one month is equal to sales plus desired ending inventory minus beginning inventory.

4-20. Solution:

Wright Lighting FixturesProduction Schedule

March April May JuneForecasted unit sales 4,000 10,000 8,000 6,000+Desired ending inventory

15,000 12,000 9,000

–Beginning inventory 6,000 15,000 12,000Units to be produced 13,000 7,000 5,000

Cash PaymentsFeb March April May

Units produced 8,000 13,000 7,000 5,000Materials ($7/unit) month after production $56,000 $91,000 $49,000Labor ($3/unit) month of production 39,000 21,000 15,000Fixed overhead 10,000 10,000 10,000Dividends 14,000Total Cash Payments $105,000 $122,000 $88,000

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21. Dina’s Lamp Company has forecast its sales in units as follows:

January 1,000February 800March 900April 1,400May 1,550June 1,800July 1,400

Dina’s always keeps an ending inventory equal to 120 percent of the next month’s expected sales. The ending inventory for December (January’s beginning inventory) is 1,200 units, which is consistent with this policy.

Materials cost $14 per unit and are paid for in the month after purchase. Labor cost is $7 per unit and is paid in the month the cost is incurred. Overhead costs are $8,000 per month. Interest of $10,000 is scheduled to be paid in March, and employee bonuses of $15,500 will be paid in June.

Prepare a monthly production schedule and a monthly summary of cash payments for January through June. Dina produced 800 units in December.

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4-21. Solution:

Dina's Lamp CompanyProduction Schedule

Jan. Feb. March April May June JulyForecasted unit sales 1,000 900 1,400 1,550 1,800 1,400+ Desired ending inventory 960 1,080 1,680 1,860 2,160 1,680– Beginning inventory 1,200 960 1,080 1,680 1,860 2,160= Units to be produced 760 920 1,500 1,580 1,850 1,320

Summary of Cash PaymentsDec. Jan. Feb. March April May June

Units produced 800 760 920 1,500 1,580 1,850 1,320Material cost ($14/unit) month after purchase $11,200 $10,640 $12,880 $21,000 $22,120 $25,900Labor cost ($5/unit) month incurred 5,320 6,440 10,500 11,060 12,950 $9,240Overhead cost 8,000 8,000 8,000 8,000 8,000 8,000Interest 10,000Employee bonuses 15,500Total Cash Payments $24,520 $25,080 $41,380 $40,060 $43,070 $58,640

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22. Graham Potato Company has projected sales of $6,000 in September, $10,000 in October, $16,000 in November, and $12,000 in December. Of the company’s sales, 20 percent are paid for by cash and 80 percent are sold on credit. Experience, shows that 40 percent of accounts receivable are paid in the month after the sale, while the remaining 60 percent are paid two months after. Determine collections for November and December.

Also assume Graham’s cash payments for November and December are $13,000 and $6,000, respectively. The beginning cash balance in November is $5,000, which is the desired minimum balance.

Prepare a cash budget with borrowing needed or repayments for November and December. (You will need to prepare a cash receipts schedule first.)

4-22. Solution:

Graham Potato CompanyCash Receipts Schedule

September October November DecemberSales $6,000 $10,000 $16,000 $12,000Credit sales (80%)

4,800 8,000 12,800 9,600

Cash sales (20%)

1,200 2,000 3,200 2,400

Collections in month after sales (40%)

3,200 5,120

Collections two months after sales (60%)

2,880 4,800

Total cash receipts $9,280 $12,320

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Graham Potato Company (Continued)Cash Budget

November DecemberCash receipts $ 9,280 $12,320Cash payments 13,000 6,000Net Cash Flow (3,720) 6,320Beginning Cash Balance 5,000 5,000Cumulative Cash Balance 1,280 11,320Monthly Loan or (Repayment)

3,720 (3,720)

Cumulative Loan Balance 3,720 -0-Ending Cash Balance $ 5,000 $ 7,600

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23. Juan’s Taco Company has restaurants in five college towns. Juan wants to expand into Austin and College Station and needs a bank loan to do this. Mr. Bryan, the banker, will finance construction if Juan can present an acceptable three-month financial plan for January through March. Following are actual and forecasted sales figures:

Actual ForecastAdditional Information

November $120,000 January $190,000 April forecast $230,000December 140,000 February 210,000

March 230,000

Of Juan’s sales, 30 percent are for cash and the remaining 70 percent are on credit. Of credit sales, 40 percent are paid in the month after sale and 60 percent are paid in the second month after the sale. Materials cost 20 percent of sales and are paid for in cash. Labor expense is 50 percent of sales and is also paid in the month of sales. Selling and administrative expense is 5 percent of sales and is also paid in the month of sales. Overhead expense is $12,000 in cash per month; depreciation expense is $25,000 per month. Taxes of $20,000 and dividends of $16,000 will be paid in March. Cash at the beginning of January is $70,000, and the minimum desired cash balance is $65,000.

For January, February, and March, prepare a schedule of monthly cash receipts, monthly cash payments, and a complete monthly cash budget with borrowings and repayments.

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4-23. Solution:

Juan's Taco CompanyCash Receipts Schedule

November December January February March AprilSales $120,000 $140,000 $190,000 $210,000 $230,000 $230,000Credit sales (70%) 84,000 98,000 133,000 147,000 161,000 161,000Cash sales (30%) 36,000 42,000 57,000 63,000 69,000 69,000Collections (month after credit sales) 40%

33,600 39,200 53,200 58,800 64,400

Collections (two months after credit sales) 60%

50,400 58,800 79,800 88,200

Total Cash Receipts $146,600 $175,000 $207,600

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4-23. (Continued)Juan’s Taco Company

Cash Payments Schedule

January February MarchPayments for Material Purchases (20% of current month’s sales) $ 38,000 $ 42,000 $46,000Labor Expense (50% of sales) 95,000 105,000 115,000Selling and Admin. Exp. (5% of sales) 9,500 10,500 11,500Overhead 12,000 12,000 12,000Taxes 20,000Dividends 16,000Total Cash Payments* $154,500 $169,500 $220,500

*The $25,000 of depreciation is excluded because it is not a cash expense.

4-23. (Continued)Juan’s Taco Company

Cash Budget

January February MarchTotal Cash Receipts $146,600 $175,000 $207,600Total Cash Payments 154,500 169,500 220,500Net Cash Flow (7,900) 5,500 (12,900)Beginning Cash Balance 70,000 65,000 67,600Cumulative Cash Balance 62,100 70,500 54,700Monthly Loan or (repayment) 2,900 (2,900) 10,300Cumulative Loan Balance 2,900 -0- 10,300Ending Cash Balance $ 65,000 $ 67,600 $ 65,000

24. Hickman Avionics’s actual sales and purchases for April and May are shown here along with forecasted sales and purchases for June through September.

Sales PurchasesApril (actual) $410,000 $220,000May (actual) 400,000 210,000June (forecast) 380,000 200,000July (forecast) 360,000 250,000August (forecast) 390,000 300,000September (forecast) 420,000 220,000

The company makes 10 percent of its sales for cash and 90 percent on credit. Of the credit sales, 20 percent are collected in the month after the sale and 80 percent are collected two months later. Hickman pays for 40 percent of its purchases in the month after purchase and 60 percent two months after.

Labor expense equals 10 percent of the current month’s sales. Overhead expense equals $15,000 per month. Interest payments of $40,000 are due in June and September. A cash dividend of $20,000 is scheduled to be paid in June. Tax payments of $35,000 are due in June and September. There is a scheduled capital outlay of $300,000 in September.

Hickman Avionics’s ending cash balance in May is $20,000. The minimum desired cash balance is $15,000. Prepare a schedule of monthly cash receipts, monthly cash payments, and a complete monthly cash budget with borrowing and repayments for June through September. The maximum desired cash balance is $50,000. Excess cash (above $50,000) is used to buy marketable securities. Marketable securities are sold before borrowing funds in case of a cash shortfall (less than $15,000).

4-24. Solution:

Hickman AvionicsCash Receipts Schedule

April May June July Aug. Sept.Sales $410,000 $400,000 $380,000 $360,000 $390,000 $420,000Credit Sales (90%) 369,000 360,000 342,00 324,000 351,000 378,000Cash Sales (10%) 41,000 40,000 38,000 36,000 39,000 42,000Collections (month after sale) 20% 73,800 72,000 68,400 64,800 70,200Collections (second month after sale) 80%

295,200 288,000 273,600 259,200Total Cash Receipts $405,200 $392,400 $377,400 $371,400

4-24. (Continued)Hickman AvionicsCash Payments Schedule

April May June July Aug. Sept.Purchases $220,000 $210,000 $200,000 $250,000 $300,000 $220,000Payments (month after purchase—40%) 88,000 84,000 80,000 100,000 120,000Payments (second month after purchase—60%) 132,000 126,000 120,000 150,000Labor Expense(10% of sales) 38,000 36,000 39,000 42,000Overhead 15,000 15,000 15,000 15,000Interest Payments 40,000 40,000Cash Dividend 20,000Taxes 35,000 35,000Capital Outlay 300,000Total Cash Payments $364,000 $257,000 $274,000 $702,000

4-24. (Continued)Hickman Avionics

Cash Budget

June July August SeptemberCash Receipts $405,200 $392,400 $377,400 $371,400Cash Payments 364,000 257,000 274,000 702,000Net Cash Flow 41,200 135,400 103,400 (330,600)Beginning Cash Balance 20,000 50,000 50,000 50,000Cumulative Cash Balance 61,200 185,400 153,400 (280,600)Monthly Borrowing or (Repayment) -- -- -- *80,600Cumulative Loan Balance -- -- -- 80,600Marketable Securities Purchased 11,200 135,400 103,400 -- (Sold) -- -- 250,000Cumulative Marketable Securities 11,200 146,600 250,000 --Ending Cash Balance 50,000 50,000 50,000 50,000*Cumulative Marketable Sec. (Aug) $250,000Cumulative Cash Balance (Sept) –280,600Required (ending) Cash Balance 50,000Monthly Borrowing –$80,600

25. Carter Paint Company has plants in nine midwestern states. Sales for last year were $100 million, and the balance sheet at year-end is similar in percentage of sales to that of previous years (and this will continue in the future). All assets (including fixed assets) and current liabilities will vary directly with sales.

BALANCE SHEET(in $ millions)

Assets Liabilities and Stockholders’ EquityCash..................................... $ 5 Accounts payable...................... $15Accounts receivable............ 15 Accrued wages.......................... 6Inventory............................. 30 Accrued taxes............................ 4 Current assets................ 50 Current liabilities...................... 25Fixed assets......................... 40 Notes payable............................ 30 . Common stock.......................... 15 . Retained earnings...................... 20

Total liabilities and Total assets.......................... $90 stockholders’ equity................ $90

Carter Paint has an aftertax profit margin of 5 percent and a dividend payout ratio of 30 percent.

If sales grow by 10 percent next year, determine how many dollars of new funds are needed to finance the expansion. (Assume Carter Paint is already using assets at full capacity and that plant must be added.)

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4-25. Solution:

Carter Paint Company

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26. Jordan Aluminum Supplies has the following financial statements, which are representative of the company’s historical average.

Income Statement

Sales...................................................... $300,000Expenses............................................... 247,000Earnings before interest and taxes........ $ 53,000Interest.................................................. 3,000Earnings before taxes............................ $ 50,000Taxes..................................................... 20,000Earnings after taxes............................... $ 30,000Dividends.............................................. $ 18,000

Balance Sheet

Assets Liabilities and Stockholders’ Equity

Cash ........................ $ 8,000 Accounts payable............. $ 6,000Accounts receivable 20,000 Accrued wages................. 2,000Inventory................. 62,000 Accrued taxes................... 4,000 Current assets... $ 90,000 Current liabilities....... $ 12,000Fixed assets............. 100,000 Notes payable................... 10,000

Long-term debt................. 20,000Common stock................. 80,000Retained earnings............. 68,000Total liabilities and

Total assets $190,000 stockholders’ equity...... $190,000

Jordan is expecting a 20 percent increase in sales next year, and management is concerned about the company’s need for external funds. The increase in sales is expected to be carried out without any expansion of fixed assets, but rather through more efficient asset utilization in the existing stores. Among liabilities, only current liabilities vary directly with sales.

Using the percent-of-sales method, determine whether Jordan Aluminum has external financing needs. (Hint: A profit margin and payout ratio must be found from the income statement.)

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4-26. Solution:

Jordan Aluminum Supplies

Change in Sales = 20% × $300,000 = $60,000

Spontaneous Assets = Current Asserts = Cash + Acc. Rec. + Inventory

Spontaneous Liabilities = Acc. Payable + Accr. Wages + Accr. Taxes

The firm needs $1,200 in external funds.

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27. Cambridge Prep Shops, a national clothing chain, had sales of $200 million last year. The business has a steady net profit margin of 12 percent and a dividend payout ratio of 40 percent. The balance sheet for the end of last year is shown below.

Balance Sheet End of Year

(in $ millions)Assets Liabilities and Stockholders’ Equity

Cash..................................... $ 10 Accounts payable................... $ 15Accounts receivable............ 15 Accrued expenses................... 5Inventory............................. 50 Other payables....................... 40Plant and equipment............ 75 Common stock....................... 30 . Retained earnings................... 60

Total liabilities and Total assets.......................... $150 stockholders’ equity............ $150

Cambridge’s marketing staff tells the president that in this coming year there will be a large increase in the demand for tweed sport coats and various shoes. A sales increase of 15 percent is forecast for the Prep Shop.

All balance sheet items are expected to maintain the same percent-of-sales relationships as last year*, except for common stock and retained earnings. No change is scheduled in the number of common stock shares outstanding, and retained earnings will change as dictated by the profits and dividend policy of the firm. (Remember the net profit margin is 12 percent.)a. Will external financing be required for the Prep Shop during the coming year?b. What would be the need for external financing if the net profit margin went up to

14 percent and the dividend payout ratio was increased to 70 percent? Explain.* This included fixed assets as the firm is at full capacity.

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4-27. Solution:

Cambridge Prep Shops

a.

A negative figure for required new funds indicates that an excess of funds ($3.06 mil.) is available for new investment. No external funds are needed.

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4-27. (Continued)

b.

The net profit margin increased slightly, from 12% to 14%, which decreases the need for external funding. The dividend payout ratio increased tremendously, however, from 40% to 70%, necessitating more external financing. The effect of the dividend policy change overpowered the effect of the net profit margin change.

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COMPREHENSIVE PROBLEM

Comprehensive Problem 1.The Landis Corporation had 2008 sales of $100 million. The balance sheet items that vary directly with sales and the profit margin are as follows:

Percent

Cash............................................................................ 5%Accounts receivable................................................... 15Inventory.................................................................... 25Net fixed assets.......................................................... 40Accounts payable....................................................... 15Accruals..................................................................... 10Profit margin after taxes............................................. 6%

The dividend payout rate is 50 percent of earnings, and the balance in retained earnings at the end of 2009 was $33 million. Common stock and the company’s long-term bonds are constant at $10 million and $5 million, respectively. Notes payable are currently $12 million.

a. How much additional external capital will be required for next year if sales increase 15 percent? (Assume that the company is already operating at full capacity.)

b. What will happen to external fund requirements if Landis Corporation reduces the payout ratio, grows at a slower rate, or suffers a decline in its profit margin? Discuss each of these separately.

c. Prepare a pro forma balance sheet for 2009 assuming that any external funds being acquired will be in the form of notes payable. Disregard the information in part b in answering this question (that is, use the original information and part a in constructing your pro forma balance sheet).

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CP 4-1 Solution:

Landis Corporation

a.

b. If Landis reduces the payout ratio, the company will retain more earnings and need less external funds. A slower growth rate means that less assets will have to be financed and in this case, less external funds would be needed. A declining profit margin will lower retained earnings and force Landis Corporation to seek more external funds.

c. Balance Sheet—December 31, 2009(Dollars in Millions)

Cash.............................. $ 5.75 Accounts Payable......... $17.25Accounts Receivable.... 17.25 Accruals....................... 11.50Inventory....................... 28.75 Notes Payable.............. 17.551

Net Fixed Assets........... 46.00 Long-Term Bonds........ 5.00Common Stock............ 10.00

_____ Retained Earnings........ 36.45 2 $97.75 $97.75

1 Original notes payable plus required new funds. This is the plug figure.2 2009 retained earnings (beginning of 2009) + PS2 (1-D) or $33 mil +

$3.45 mil

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Comprehensive Problem 2

The difficult part of solving a problem of this nature is to know what to do with the information contained within a story problem. Therefore, this problem will be easier to complete if you rely on Chapter 4 for the format of all required schedules.

The Adams Corporation makes standard-size 2-inch fasteners, which it sells for $155 per thousand. Mr. Adams is the majority owner and manages the inventory and finances of the company. He estimates sales for the following months to be:

January................................... $263,500 (1,700,000 fasteners)February................................. $186,000 (1,200,000 fasteners)March..................................... $217,000 (1,400,000 fasteners)April....................................... $310,000 (2,000,000 fasteners)May........................................ $387,500 (2,500,000 fasteners)

Last year Adams Corporation’s sales were $175,000 in November and $232,500 in December (1,500,000 fasteners).

Mr. Adams is preparing for a meeting with his banker to arrange the financing for the first quarter. Based on his sales forecast and the following information he has provided, your job as his new financial analyst is to prepare a monthly cash budget, monthly and quarterly pro forma income statements, a pro forma quarterly balance sheet, and all necessary supporting schedules for the first quarter.

Past history shows that Adams Corporation collects 50 percent of its accounts receivable in the normal 30-day credit period (the month after the sale) and the other 50 percent in 60 days (two months after the sale). It pays for its materials 30 days after receipt. In general, Mr. Adams likes to keep a two-month supply of inventory in anticipation of sales. Inventory at the beginning of December was 2,600,000 units. (This was not equal to his desired two-month supply.)

The major cost of production is the purchase of raw materials in the form of steel rods, which are cut, threaded, and finished. Last year raw material costs were $52 per 1,000 fasteners, but Mr. Adams has just been notified that material costs have risen, effective January 1, to $60 per 1,000 fasteners. The Adams Corporation uses FIFO inventory accounting. Labor costs are relatively constant at $20 per thousand fasteners, since workers are paid on a piecework basis. Overhead is allocated at $10 per thousand units, and selling and administrative expense is 20 percent of sales. Labor expense and overhead are direct cash outflows paid in the month incurred, while interest and taxes are paid quarterly.

The corporation usually maintains a minimum cash balance of $25,000, and it puts its excess cash into marketable securities. The average tax rate is 40 percent, and Mr. Adams usually pays out 50 percent of net income in dividends to stockholders. Marketable securities are sold before funds are borrowed when a cash shortage is faced. Ignore the interest on any short-term borrowings. Interest on the long-term debt is paid in March, as are taxes and dividends.

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Comprehensive Problem 2. (Continued)

As of year-end, the Adams Corporation balance sheet was as follows:

ADAMS CORPORATIONBalance Sheet

December 31, 200X

Assets

Current assets:Cash........................................................................$ 30,000Accounts receivable................................................ 320,000Inventory................................................................. 237,800

Total current assets............................................. $ 587,800Fixed assets:

Plant and equipment...............................................1,000,000Less: Accumulated depreciation......................... 200,000 800,000

Total assets................................................................. $1,387,800Liabilities and Stockholders’ Equity

Accounts payable....................................................... $ 93,600Notes payable............................................................. 0Long-term debt, 8 percent.......................................... 400,000Common stock........................................................... 504,200Retained earnings....................................................... 390,000 Total liabilities and stockholders’ equity................... $1,387,800

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CP 4-2. Solution:

Adams CorporationMonthly Cash Receipts

Nov. Dec. Jan. Feb. Mar.Sales $175,000 $232,500 $263,500 $186,000 $217,000Collections (50% of Previous month) 87,500 $116,250 131,750 93,000Collections (50% of 2 months earlier) 87,500 116,250 131,750Total Collections $203,750 $248,000 $224,750

Monthly Cash Flow

January February MarchCash Receipts $203,750 $248,000 $224,750Cash Payments 188,300 181,200 359,380Net Cash Flow 15,450 66,800 (134,630)

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CP 4-2. (Continued)

Adams CorporationCash Budget

January February MarchNet Cash Flow $15,450 $66,800 $(134,630)Beginning Cash Balance 30,000 25,000 25,000Cumulative Cash Balance $45,450 $91,800 ($109,630)Loans and (Repayments) -0- -0- 47,380Cumulative Loans -0- -0- 47,380Marketable Securities 20,450 66,800 (87,250)Cumulative Marketable Securities

20,450 87,250 -0-

Ending Cash Balance $25,000 $25,000 $25,000

Adams CorporationPro Forma Income Statement

Jan. Feb. Mar. TotalSales $263,500 $186,000 $217,000 $666,500Cost of Goods Sold 139,400 98,400 126,000 363,800 Gross Profit 124,100 87,600 91,000 302,700Selling and Admin. Expense 52,700 37,200 43,400 133,300

Interest Expense 2,667 2,667 2,666 8,000 Net Profit Before Tax $ 68,733 $ 47,733 $ 44,934 $161,400

Taxes 27,493 19,093 17,974 64,560 Net Profit After Tax $ 41,240 $ 28,640 $ 26,960 $ 96,840Less: Common Dividends 48,420

Increase in Retained Earnings $ 48,420

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CP 4-2. (Continued)

Adams CorporationCost of Goods Sold

Unit Cost per thousand before January 1st

Unit cost per thousand after January 1st

Material............. $52 $60Labor................. 20 20Overhead........... 10 10

$82 $90

Ending inventory as of December 31 was 2,900,000, therefore, sales for January and February had a cost of goods sold per thousand units of $82, and March sales reflect the increased cost of $90 per thousand units using FIFO inventory methods.

Pro Forma Balance Sheet (March)

Assets Liabilities & Stockholders' Equity

Current Assets: Current Liabilities:Cash............................ $ 25,000 Accounts Payable $ 150,000Accounts Receivable 310,000 Notes Payable 47,380Inventory.................... 405,000 Long-Term Debt 400,000

Stockholders' Equity:Plant & Equip: 800,000 Common Stock 504,200

Retained Earnings 438,420Total Assets

$1,540,000Total Liabilities & Stockholders' Equity $1,540,000

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CP 4-2. (Continued)

Explanation of Changes in the Balance Sheet:Cash = ending cash balance from cash budget in MarchAccounts receivable =

all of March sales plus 50% of Feb. sales

$217,00093,000

$310,000

Inventory = ending inventory in March of 4,500,000 units at $90 per thousand

Plant and equipment did not change since we did not include depreciation.

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WEB EXERCISE

The Borders Group was discussed at the beginning of the chapter as a company in transition. Go to www.bordersgroupinc.com.

1. Click on “About Us.” In two paragraphs, write a summary of the company profile.

2. Then click on “Investors.”

3. Then click on stock chart. How has the stock been performing over the last 12 months.

4. Then click on “Press Releases.” Click on the press release that covers Borders’ most recent quarterly (Q) performance. Generally speaking, how well has the company been doing?

Note: From time to time, companies redesign their Web sites and occasionally a topic we have listed may have been deleted, updated, or moved into a different location. If you click on the site map or site index, you will be introduced to a table of contents which should aid you in finding the topic you are looking for.

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