1.

Baldwin Products Company anticipates reaching a sales level of $6 million in

one year. The company expects net income during the next year to equal
$400,000. Over the past several years, the company has been paying $50,000
in
dividends to its stockholders. The company expects to continue this policy for
at least the next year. The actual balance sheet and income statement for
Baldwin during 2005 follow.

Baldwin Products Company

Balance Sheet as of December 31, 2005
Cash $ 200,000 Accounts payable $ 600,000
Accounts receivable 400,000 Notes payable 500,000
Inventories 1,200,000 Current liabilities $1,100,000
Current assets $1,800,000 Long-term debt 200,000
Fixed assets, net 500,000 Stockholders’ equity 1,000,000
Total assets $2,300,000 Total liabilities and equity $2,300,000
Income Statement for the Year Ending December 31, 2005
Sales $4,000,000
Expenses, including interest and taxes $3,700,000
Net income $ 300,000

a. Using the percentage of sales method, calculate the additional financing

Baldwin Products will need over the next year at the $6 million sales level.
Show the pro forma balance sheet for the company as of December 31,
2006, assuming a sales level of $6 million is reached. Assume that all assets
vary proportionally with sales. Accounts payable is the only liability that
varies proportionally with sales. Assume that the additional financing
needed is obtained in the form of additional notes payable (in other words,
assume that notes payable is the “plug” figure).
b. Suppose that the Baldwin Products’ management feels that the average
collection
period on its additional sales—that is, sales over $4 million—will be
60 days, instead of the current level. By what amount will this increase in
the average collection period increase the financing needed by the company
over the next year?
c. If the Baldwin Products’ banker requires the company to maintain a current
ratio equal to 1.6 or greater, what is the maximum amount of additional
financing that can be in the form of bank borrowings (notes
payable)? What other potential sources of financing are available to the
company?

a. A = $2,300,000 S = $4,000,000 S = $2,000,000

D = $50,000 EAT = $400,000 CL = $600,000
Additional
Financing = [(A/S)(S) - (CL/S)(S)] - [EAT - D]
Needed
= [(2,300,000/4,000,000)(2,000,000)
- (600,000/4,000,000)(2,000,000)]
- [400,000 - 50,000]
 = $500,000

Pro Forma Balance Sheet as of Dec. 31, 2009

Assets Liabilities
Cash $300,000 Accounts Payable $900,000
Accounts Receivable 600,000 Notes Payable 1,000,000
Inventories 1,800,000 Long-term Debt 200,000
Fixed Assets, net 750,000 Stockholders’ Equity 1,350,000
Total Assets $3,450,000 Total Liabilities and
Stockholders' Equity $3,450,000

b. Projected additional sales are $2,000,000.

The required investment in accounts receivable for the projected

sales increase, assuming a 60-day average collection period is

$2,000,000 x (60/365) = $328,767

The increase in accounts receivable projected in Part a is

$200,000. Therefore, a 60-day average collection period will

increase the additional financing needed by

$328,767 - $200,000 = $128,767

c. Pro forma current ratio = 1.6

1.6 = ($300,000 + $600,000 + $1,800,000)/CL

CL = $1,687,500

The pro forma current liabilities before any additional financing is

$1,400,000 (i.e., A/P = $900,000 and N/P = $500,000). Therefore a

maximum of:

$1,687,500 - $1,400,000 = $287,500

could be in additional N/P. The remainder of the needed financing

would have to be either LTD (possibly secured by the increase in F/A) or

equity.