Attribution Non-Commercial (BY-NC)

1.8K views

Attribution Non-Commercial (BY-NC)

- Holly Fashions case
- The Structure of Financial Management Course_10_11
- Holly Fashions
- Case Time Value of Money
- Tipton Ice Cream
- Horton Building Supplies Assi 2 Complete
- Case Studies Financial Management
- 6 Holly Fashion Case Study
- Thompson Telescopes
- Franklin Lumber
- Case Studies Time Value of Money
- Ratio Analysis_Holly Fashion
- Tipton Ice Cream Sheet Empty
- JA Umaji Cooperative Case Study Final Version
- GROUP1_Umaji.docx
- 30 Taylor Brand Solution
- Solutions Case 1
- Case Solution Holly Fashion
- Finance Solved Cases
- 395 37 Solutions Case Studies 4 Time Value Money Case Solutions Chapter 4 FM

You are on page 1of 6

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.

- Holly Fashions caseUploaded byMarek
- The Structure of Financial Management Course_10_11Uploaded byLorena Bala
- Holly FashionsUploaded byKhaled Darweesh
- Case Time Value of MoneyUploaded byHasibul Islam
- Tipton Ice CreamUploaded bycesarvirata
- Horton Building Supplies Assi 2 CompleteUploaded byEmad Rashid
- Case Studies Financial ManagementUploaded byradulescuaura2014
- 6 Holly Fashion Case StudyUploaded byCaramalau Mirela-Georgiana
- Thompson TelescopesUploaded byabhishek2006
- Franklin LumberUploaded byjhanzab
- Case Studies Time Value of MoneyUploaded bySyed Sohail Shah
- Ratio Analysis_Holly FashionUploaded byCarmen Popescu-Duta
- Tipton Ice Cream Sheet EmptyUploaded byAli Raza
- JA Umaji Cooperative Case Study Final VersionUploaded byMargarita Sison
- GROUP1_Umaji.docxUploaded byKevin Matibag
- 30 Taylor Brand SolutionUploaded byradulescuaura2014
- Solutions Case 1Uploaded byMerryum Javed
- Case Solution Holly FashionUploaded byHasibul Islam
- Finance Solved CasesUploaded by074132019
- 395 37 Solutions Case Studies 4 Time Value Money Case Solutions Chapter 4 FMUploaded byblazeweaver
- Case Studies in FinanceUploaded bygideon mbatha
- Triad Campers(14)Uploaded byKhaled Darweesh
- Reed's Clothier Case StudyUploaded byColleen Sieger Mueller
- Fa11 Fin 650 SagnerUploaded byFuzael Amin
- DocumentUploaded byzohaib bilgrami
- Amtrak Ppt SolutionsUploaded byAngela Thornton
- Assignment 1Uploaded byAmmar Naqvi
- Q1Uploaded byMuhammad Umer Saigol
- Greenworld Case SOLUTIONUploaded byMahamIbrahim
- Competitive advantage of Low-Cost Carriers in the PhilippinesUploaded bymelissatabanag

- Global Business implicationsUploaded byjjhixon
- Complaint for Declaratory and Injunctive ReliefUploaded byTim Durken
- New International FinanceUploaded byBK Bharti
- STR 581 Final Exam Capstone Part 2 Week 4Uploaded byMike Russell
- Chapter 19Uploaded byTristan Ferrer
- COM670 Chapter 4Uploaded byaakaps
- Swift 2002 Annual ReportUploaded byFlaviub23
- 19.pdfUploaded byKevin Che
- Principles of finance test bank chapter 8Uploaded byHassaan Shaikh
- Foreign CurrencyUploaded byYamna Fakher
- MKIBN20080331-0016EUploaded byberznik
- Epoxy Composites: Impact Resistance and Flame RetardancyUploaded byamitn18
- Private Security Companies in the Czech Republic: An Exploratory AnalysisUploaded byCentral European Journal of International and Security Studies
- accountingUploaded bywolverine
- Bexar County, Texas 2013-14 BudgetUploaded byrp61
- Chapter 12Uploaded byangelgirllll
- ACC422 Wiley CPA Excel Chapters 21 AnswersUploaded bykixbenn1
- Pialef Ar WebUploaded byFaisal
- Euro Adv Si InncUploaded byValentin Vochita
- Tender Offer for EEA Life Settlements Fund PCCUploaded bySouthey Capital
- b Plan of Coffe & Spa Executive Summary (1)Uploaded byPritika Jagadale
- Text of the Draft Agreement AIICUploaded byNancyBA
- Literature Review on foreign exchange.docxUploaded byChetan Sahu
- Cityam 2011-06-15Uploaded byCity A.M.
- RR_700000275Uploaded byRohit Chandra
- intralotUploaded byjulianrogers77
- Disney PresentationUploaded byOllie Goh
- City of Peterborough 2018 budget guidelinesUploaded byPeterborough Examiner
- Currency Trader Magazine 2011-08Uploaded byLascu Roman
- MoneyTimesUploaded bypasamv

## Much more than documents.

Discover everything Scribd has to offer, including books and audiobooks from major publishers.

Cancel anytime.