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Toy World, Inc.
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Category: Miscellaneous Autor: anton 29 December 2010 Words: 1456 | Pages: 6

Toy World, Inc. is a fairly healthy toy manufacturing business that is looking at a cross roads in it's main operating procedure. Jack McClintock is President and partial owner of Toy World. His new production manager, Dan Hoffman, has been on the job through one business cycle (about one year). This toy business is a seasonal business with most of the sales coming between August and December. Since its inception Toy World has followed a seasonal production schedule to match customer demand. After Hoffman's short time one the job he has become concerned with Toy World's method of scheduling production. He has urged McClintock to change methods to a level production schedule (same amount of production hours each month). Hoffman's main arguments are that Toy World could save money at about $225k from overtime premiums during peak production times as well as an additional $265k from a more orderly production process. Hoffman has also conceded that part of the savings would be offset by about $115k in additional storage and handling costs. Another important factor in Hoffman's case is that Toy World will approach full capacity during 1994's peak season production. Due to recent expansions Toy World has a strained working capital position and would most likely have trouble affording another expansion in the near future.

Any incorrect estimates and not enough products may be produced. Not only does this help with the cost of training and recruiting. and Tax Payments. Meaning that Toy World's already weak cash position will most likely become weaker during the low sales months. In order to calculate cash on hand the beginning cash is added to the total cash in and then subtracted from the total cash out. Cash out is derived from Repayment of Long Term Debt. If Toy World were to produce too many of one product they may be forced to either sell at a loss or hold the product for next year in hopes that there will be additional demand for it then. The favorability is partially offset by the extra $115k in storage. as per Hoffman. Production Expenses. The employees will be happier as they know that their jobs are secure. Line of Credit payments are the maximum amount available while keeping the minimum 200k on hand balance. This could easily happen as sometimes product sales vary by 30 В– 35% per year. If the Net Profit is put to a Net Present Value (NPV) based on a fifteen percent discount rate (11% premium over Toy World's risk free rate of 4%) with no terminal value the switch in production methods is worth $163k in 1994. Production . Under the current system Toy World would only run at 25 В– 30% capacity during the first seven months of the year and then run near full the remaining five months. It had been previously determined that Toy World would need to have at least 200k of cash on hand at the end of each month as this is considered the minimum required amount to operate the business. it also builds goodwill with the Toy World production employees. Per Hoffman's analysis Toy World would have to run at full capacity (16 hours per day) during the peak season to meet the upcoming sales demand if they are to continue the seasonal production schedule. To calculate cash in Monthly Sales are added to the net change in Accounts Receivable then interest income is added and finally Line of Credit disbursement is added. However. Also.McClintock knows that Hoffman may be onto something but there is more to this decision than meets the eyes. a difference of $187k (exhibit 5). Operating Expenses. One of the biggest favorable factors that is truly hard to put into pure financial numbers is the switch would solve Toy World's upcoming capacity issues. Another thing that should concern McClintock is that producing on a level basis means that inventory will have to be built without much cash coming in. if Toy World were to run at a consistent capacity then they would also be able to keep a consistent work force. If Toy World were to switch to the level production schedule system then they would most likely run at a constant 60% to capacity. and an additional $95k in marginal tax. McClintock must also weigh the intangible factors in the production schedule switch for Toy World. Exhibit 3 details the expected cash position on a monthly basis. The Long Term Debt is amortized at 25k in June and December. With a first look at the financials and Hoffman's case to move to level production schedules it seems to be a no-brainer for Toy World. However good the financials look. not all the intangible aspects are positive. $93k in extra interest. or even worse too many products may be produced. In a level production environment sales forecasts per product type would dictate what should be built. This increase is powered by the $490k savings from reduced overtime and orderly production. One potentially negative issue that McClintock should be concerned with is that currently Toy World sets it's production schedule to customer orders. Line of Credit payments. Looking at exhibit 4 the income statement for a level production type in 1994 shows a Net Profit of $538k.

this is the amount due on top of the prior year estimated payments. There are a couple of inherent problems with this. The second problem is in securing the additional funds to surpass the two million dollar mark. McClintock should also point out that this additional limit is needed to switch the production method of the company which will in turn increase profitability. McClintock has a few options to secure the additional funds. The most concerning thing about the needed line of credit balance is that it will exceed the pre-negotiated two million dollar mark in six of the twelve months. The only difference would be the long term structure of the note possibly hurting Toy World in their future expansion of the company. While looking at Exhibit 3 McClintock can see that the line of credit with City Trust Company is going to have to be much more active than in prio years. To make City Trust Company more willing to go along with the higher limit McClintock could offer to secure the loan with Toy World inventory in addition to the Accounts Receivable already used. McClintock could use the same arguments as the line of credit increase as well as the fact. A second option that McClintock has is to try to obtain additional long term debt to cover the one point three million. Finally there is one payment for tax due from prior year. $752k). An approximate one point three million additional funds will need to be secured. The transformation to level production schedules brings with it some risk. They may also want to allow the greater limit as it will allow City Trust Company to bring in additional interest income of their own. One. A detail is show at the bottom of Exhibit 3 for the Line of Credit Balance. having a large balance on the line of credit causes additional interest expense (see exhibit 5) of $93k for a total interest expense of $188k (see exhibit 4). City Trust Company may go for the higher balance as Toy World will at the end of the year have a lower balance than the beginning of the year ($733k vs.expenses and Operating expenses are estimated straight line across each month as production levels should be the same every month. He could go to the line of credit provider and try to negotiate a higher limit. Read Full Essay . Estimated tax payments are made three times a year based on the prior year tax due. but with necessary risk comes the opportunity for reward. A final point that McClintock should make is that Toy World will still be able to have the note at a zero balance for at least thirty days of each year as per the original understanding. After weighing all the pros and cons it seems as though Hoffman was right that moving to a level production schedule will increase performance and profitability. It will be even more important that sales forecasts are correct not just to the volume but to the product as well. In order to make the move successful great planning and care will need to go into the transformation.

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