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Chapter 4

Questions and Problems

Discussion Questions

4-1.

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

 

 

4-2.

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

 

 

4-3.

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

 

 

4-4.

Explain the relationship between inventory turnover and purchasing needs.

 

4-5.

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

 

 

4-6.

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

 

 

4-7.

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

Problems

4-1.

Philip Morris is very excited because sales for his clothing company was expected to double from $500,000 to $1,000,000 next year. Philip notes that net assets (assets – liabilities) will remain at 50 percent of sales. His clothing firm will enjoy a 9 percent return on total sales. He will start the year with $100,000 in the bank and is bragging about the two Mercedes he will buy and the European vacation he will take. 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. 

 

 

4-2.

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

 

4-3.

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

 

Outcome

Probability

Units

Price

 

A

0.30

200

$15

 

B

0.50

320

$30

 

C 

0.20

410

$40

 

 

4-4.

Sales for Western Boot Stores are expected to be 40,000 units for October. The company likes to maintain 15 percent of units sales for each month in ending inventory (i.e., the end of October). Beginning inventory for October is 8,500 units. How many units should Western Boot produce for the coming month? 

 

4-5.

Vitale Hair Spray had sales of 8,000 units in March. A 50 percent increase is expected in April. The company will maintain five percent of expected unit sales for April in ending inventory. Beginning inventory for April was 400 units. How many units should the company produce in April? 

 

 

4-6.

Delsing Plumbing Company has beginning inventory of 14,000 units, will sell 50,000 units for the month, and desires to reduce ending inventory to 40 percent of beginning inventory. How many units should Delsing produce? 

 

4-7.

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)? 

 

4-8.

At the end of January, Higgins Data Systems had an inventory of 600 units which cost $16 per unit to produce. During February the company produced 850 units at a cost of $19 per unit. If the firm sold 1,100 units in February, what was its cost of goods sold? (Assume LIFO inventory accounting.) 

 

 

4-9.

The Bradley Corporation produces a product with the following costs as of July 1, 2001: 

 

Material . . . . . . . .  $2 per unit

Labor . . . . . . . . . .    4 per unit

Overhead . . . . . . .    2 per unit 

Beginning inventory at these costs on July 1 was 3,000 units. From July 1 to December 31, 2001, Bradley produced 12,000 units. These units had a material cost of $3, labor of $5, and overhead of $3 per unit. Bradley uses FIFO inventory accounting. 

Assuming that Bradley sold 13,000 units during the last six months of the year at $16 each, what is their gross profit? What is the value of ending inventory? 

4-10.

Assume in problem 9 that the Bradley Corporation used LIFO accounting instead of FIFO, what would gross profit be? What would be the value of ending inventory?

 

 

 

4-11.

Sprint Shoes, Inc., had a beginning inventory of 9,000 units on January 1, 2001.

 The costs associated with the inventory were:

 Material . . . . . . . .  $13.00 per unit

Labor . . . . . . . . . .      8.00 per unit

Overhead . . . . . . .      6.10 per unit

 During 2001, they produced 42,500 units with the following costs:

 Material . . . . . . . .  $15.50 per unit

Labor . . . . . . . . . .      7.80 per unit

Overhead . . . . . . .      8.30 per unit

 Sales for the year were 47,250 units at $39.60 each. Sprint Shoes uses LIFO accounting. What was the gross profit? What was the value of ending inventory? 

 

 

4-12.

Victoria's Apparel has forecast credit sales for the fourth quarter of the year as: 

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

                       Fourth Quarter

October.......................................... $40,000

November.......................................   35,000

December.......................................   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). 

  

 

4-13.

Watt's Lighting Stores made the following sales projections for the next six months. All sales are credit sales. 

 

March................................ $30,000

June.............................      $34,000

 

April..................................... 36,000

July..............................        42,000

 

May..................................... 25,000 

August.........................        44,000

 

Sales in January and February were $33,000 and $32,000, 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? 

 

4-14.

Ultravision, Inc. anticipates sales of $240,000 from January through April. Materials will represent 50 percent of sales and because of level production, material purchases will be equal for each month over the four months of January, February, March, and April.

 Materials are paid for after the month purchased. Materials purchased in December of last year were $20,000 (half of $40,000 in sales), labor costs for each of the four months are slightly different due to a provision in a labor contract in which bonuses are paid in February and April. The labor figures are: 

       January                $10,000

       February              $13,000

       March                  $10,000

       April                     $15,000

 

Fixed overhead is $6,000 per month. Prepare a schedule of cash payments for January through April.

 

4-15.

The Denver Corporation has forecast the following sales for the first seven months of the year: 

 

January............................... $10,000

May............................      $10,000

 

February.............................. 12,000

June.............................        16,000

 

March.................................. 14,000

April..................................... 20,000 

July..............................        18,000

 

Monthly material purchases are set equal to 30 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 $4,000 per month, and fixed overhead is $2,000 per month. Interest payments on the debt will be $3,000 for both March and June. Finally, the Denver salesforce will receive a 1.5 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.) 

 

4-16.

The Boswell Corporation forecasts its sale in units for the next four months as follows:

March............................................. $6,000

April................................................   8,000

May................................................   5,500

June..........................................       4,000

 Boswell 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 $5 per unit and are paid for in the month after production. Labor cost is $10 per unit and is paid for in the month incurred. Fixed overhead is $12,000 per month. Dividends of $20,000 are to be paid in May. Five thousand units were produced in February.

 Compute 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.

 

 

4-17.

The Volt Battery Company has forecast its sales in units as follows: 

 

January...................................... 800

May...............................       1,350

 

February................................... 650

June................................       1,500

 

March....................................... 600

April....................................... 1,100 

July.................................       1,200

 

Volt Battery 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 960 units, which is consistent with this policy.

Materials cost $12 per unit and are paid for the month after purchase. Labor cost is $5 per unit and is paid in the month the cost is incurred. Overhead costs are $6,000 per month. Interest of $8,000 is scheduled to be paid in March, and employee bonuses of $13,200 will be paid in June. 

Prepare a monthly production schedule and a monthly summary of cash payments for January through June. Volt produced 600 units in December.  

 

4-18.

Lansing Auto Parts, Inc., has projected sales of $25,000 in October, $35,000 in November, and $30,000 in December. Of the company's sales, 20 percent are paid for by cash and 80 percent are sold on credit. The credit sales are collected one month after sale. Determine collections for November and December. 

Also assume that the company's cash payments for November and December are $30,400 and $29,800, respectively. The beginning cash balance in November is $6,000, 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.) 

 

 

4-19.

Harry's Carryout Stores has eight locations. The firm wishes to expand by two more stores and needs a bank long to do this. Mr. Wilson, the banker, will finance construction if the firm can present an acceptable three-month financial plan for January through March. The following are actual and forecasted sales figures:

 

 

Actual

Forecast

Additional Information

 

November... $200,000

January..... $280,000

April forecast.... $330,000

 

December..... 220,000

February..... 320,000

 

 

 

March......... 340,000

 

 

 

Of the firm's sales, 40 percent are for cash and the remaining 60 percent are on credit. Of credit sales, 30 percent are paid in the month after sale and 70 percent are paid in the second month after the sale. Materials cost 30 percent of sales and are purchased and received each month in an amount sufficient to cover the following month's expected sales. Materials are paid for in the month after they are received. Labor expense is 40 percent of sales and is paid in the month of sales. Selling and administrative expense is 5 percent of sales and is also paid in the month of sale. Overhead expense is $28,000 in cash per month. Depreciation expense is $10,000 per month. Taxes of $8,000 will be paid in January, and dividends of $2,000 will be paid in March. Cash at the beginning of January is $80,000 and the minimum desired cash balance is $75,000. 

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.

 

 

 

4-20.

Archer Electronics Company's actual sales and purchases for April and May are shown here along with forecasted sales and purchases for June through September. 

 

 

Sales

Purchases

 

April (actual).........................................

$320,000

$130,000

 

May (actual)..........................................

300,000

120,000

 

June (forecast).......................................

275,000

120,000

 

July (forecast)

275,000

180,000

 

August (forecast)

290,000

200,000

 

September (forecast) 

330,000

170,000

 

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 after. Archer 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 $12,000 per month. Interest payments of $30,000 are due in June and September. A cash dividend of $50,000 is scheduled to be paid in June. Tax payments of $25,000 are due in June and September. There is a scheduled capital outlay of $300,000 in September. 

Archer Electronics' ending cash balance in May is $20,000. The minimum desired cash balance is $10,000. 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 $10,000). 
 

4-21.

Owen's Electronics has 90 operating plants in seven southwestern 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' Equity

 

Cash................................. $  2

Accounts payable..................       $15

 

Accounts receivable............... 20

Accrued wages......................           2

 

Inventory...........................   23

Accrued taxes........................       8

 

  Current assets.................. $45

  Current liabilities................       $25

 

Fixed assets.......................   40

Notes payable.......................         10

 

 

Common stock......................         15

 

 

Retained earnings...................       35

 

 

Total assets......................... $85 

Total liabilities and
  stockholders' equity...........      
$85

 

Owen's has an aftertax profit margin of 7 percent and a dividend payout ratio of 40 percent. 

If sales grow by 10 percent next year, determine how many dollars of new funds are needed to finance the growth. 

 

4-22.

The Manning Company has the following financial statements, which are representative of the company's historical average. 

 

Income Statement

 

Sales..........................................................................

$200,000

 

Expenses....................................................................

  158,000

 

Earnings before interest and taxes................................

$  42,000

 

Interest.......................................................................

      7,000

 

Earnings before taxes..................................................

$  35,000

 

Taxes.........................................................................

    15,000

 

Earnings after taxes.....................................................

  20,000

 

Dividends...................................................................

$   6,000 

 

 

Balance Sheet 

 

Assets

Liabilities and Stockholders' Equity

 

Cash.......................... $    5,000

Accounts payable............... $  25,000

 

Accounts receivable........... 40,000

Accrued wages...................          1,000

 

Inventory....................     75,000

Accrued taxes.....................       2,000

 

  Current assets............ $120,000

  Current liabilities............. $  28,000

 

Fixed assets................     80,000

Notes payable....................          7,000

 

 

Long-term debt...................        15,000

 

 

Common stock...................    120,000

 

 

Retained earnings................     30,000

 

 

Total assets................... $200,000

Total liabilities and
  stockholders' equity........   
$200,000

 

The firm 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 store. Among liabilities, only current liabilities vary directly with sales. 

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

  

4-23.

Conn Man's Shops, Inc., a national clothing chain, had sales of $300 million last year. The business has a steady net profit margin of 8 percent and a dividend payout ratio of 25 percent. The balance sheet for the end of last year is shown below. 

 

Balance Sheet

End of Year
($ millions)
 

 

Assets

Liabilities and Stockholders' Equity

 

Cash............................... $  20

Accounts payable..................   $  70

 

Accounts receivable............... 25

Accrued expenses..................         20

 

Inventory...........................   75

Other payables......................         30

 

Plant and equipment.........   120

Common stock......................         40

 

 

Retained earnings...................     80

 

 Total assets....................... $240 

Total liabilities and
  stockholders' equity...........    
$240

 

The firm's marketing staff has told the president that in the coming year there will be a large increase in the demand for overcoats and wool slacks. A sales increase of 15 percent is forecast for the company. 

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 8 percent.) 

a.     Will external financing be required for the company during the coming year?

b.     What would be the need for external financing if the net profit margin went up to 9.5 percent and the dividend payout ratio was increased to 50 percent? Explain.