Mr. "Great" Kid, an experienced budget analyst at ToysForAll Manufacturing company, has been charged with assessing the firm's financial performance during 2014 and its financial position at year end 2014.
To complete this assignment, he gathered the firm's 2014 financial statement (exhibit 1).
In addition, Mr. "Great" Kid obtained the firm's ratio value for 2013 and 2012, along with the 2014 industry average ratios (also applicable to 2013 and 2012). These are presented in exhibit 2. The income statement for 2014 has been summarized on the following Table.
Table 1.
ToysForAll Company
Income Statement
For the year ended December 31, 2014
Sales revenue $10,150,000
(-) Cost of goods sold 7,408,000
Gross profits 2,742,000
(-) Operating expenses
Selling expense 1,300,000
General & Adm. Exp. 832,000
Depreciation exp. 304,000
Total Operating exp. 2,436,000
Operating profits 306,000
(-) interest exp. 186,000
Net profits before taxes 120,000
(-) taxes (rate = 30%) 36,000
Net profits after taxes 84,000
(-) preferred stock dividends 6,000
Earnings available for common stockholders 78,000
Earnings per share (EPS) $0,78
To improve its competitive position ToysForAll is planning to implement a major equipment modernization program. Included will be replacement and modernization of key manufacturing equipment at a cost of $800.000 in 2015.
The planned program is expected to lower the variable cost per unit of finished product.
Mr. "Great" Kid, as one of the experienced budget analyst, has been charged with preparing a forecast of the firm's 2015 financial position, assuming replacement and modernization of manufacturing equipment. He plans to use the 2014 financial statements presented on exhibit 1 and 2, along with the key projected financial data summarized in the following table.
Table 2.
ToysForAll Company
Key projected financial data (2015)
Data item value
Sales revenue $13,000,000
Minimum cash balance 50,000
Inventory turnover (times) 7.0
Average collection period 50 days
Fixed assets purchases 800,000
Total dividend payments (preferred and common) 40,000
Depreciation expense 370,000
Interest expense 194,000
Accounts payable increase 20%
Accruals and long term debt unchanged
Notes payable, preferred and common stock unchanged
You have been asked to help Mr. "Great" Kid to calculate the firm's 2014 financial ratio (note: assume a year = 365 days) and then analyze the firm's current financial position from both a cross sectional and a time series view point, and finally summarize the firm's overall financial position on the basis of your findings in analysis and evaluation of the firm's profitability, liquidity, activity, solvability, and market.
After analyzing financial position of ToysForAll Company, Mr. "Great" Kid use the historical and projected financial data provided to prepare a pro forma income statement for the year ended December 31, 2015 and the pro forma balance sheet at December 31, 2015. The Board of Directors also asked Mr. "Great" Kid to explain, why will ToysForAll company need to obtain external financing to fund the proposed equipment modernization program?
Meanwhile ToysKid, Inc., is a toys fabrication firm which manufactures toys spare parts for customers in a variety of models. The firm's motto is "If you need it, we can make it". The CEO of ToysKid recently held a board meeting during which he extolled the virtues of the corporation. The company, he stated confidently, had the capability to build any product and could do so using a lean manufacturing model.
The firm would soon be profitable, claimed the CEO, because the company used state of the art technology to build a variety of products while keeping inventory levels low.
As a Future Business Leader, you have calculated some ratio to analyze the financial health of the firm. ToysKid's current ratios and quick ratios for the past six years are shown in the table below:
|
2009
|
2010
|
2011
|
2012
|
2013
|
2014
|
|
Current ratio
|
1.2
|
1.4
|
1.3
|
1.6
|
1.8
|
2.2
|
|
Quick ratio
|
1.1
|
1.3
|
1.2
|
0.8
|
0.6
|
0.4
|
What do you think of the CEO's claim that the firm is lean and soon to be profitable?
After finishing analysis of company performance and preparation of pro forma budget, the Board of Directors ToysForAll also asking to Mr."Great" Kid and his Team to develop relevant cash flows for "SisterToys" Company's machine renewal or replacement decision (SisterToys is the sister company of ToysForAll)
Board of Directors expect the firm's net operating profit after taxes for the next 5 years to be as shown in the following table.
Mr. "Great" Kid is beginning to develop the relevant cash flows needed to analyze whether to renew or replace SisterToys only depreciable asset, a machine that originally cost $60,000, has a current book value of zero, and now be sold for $40,000.
He estimates that at the end of 5 years, the existing machine can be sold to net $4,000 before taxes. Mr. "Great" Kid plans to use the following information to develop the relevant cash flows for each of the alternatives.
Alternative 1.
Renew the existing machine at a total depreciable of $180,000. The renewed machine would have a 5 year usable life and would be depreciated under straight line depreciation method. Renewing the machine would result in the following projected revenues and expenses (excluding depreciation and interest):
|
Year
|
revenue
|
Expenses (excl.depr.and int.)
|
|
1
|
$2,000,000
|
$1,603,000
|
|
2
|
2,350,000
|
1,768,400
|
|
3
|
2,600,000
|
1,836,200
|
|
4
|
2,850,000
|
1,886,200
|
|
5
|
3,100,000
|
1,936,200
|
The renewed machine would result in an increased investment in net working capital of $30,000. At the end of 5 years, the machine could be sold to net $16,000 before taxes.
Alternative 2.
Replace the existing machine with a new machine that costs $200,000 and requires installation costs of $20,000. The new machine would have a 5 year usable life and would be depreciated under straight line depreciation method. The firm's projected revenues and expenses (excluding depreciation and interest), if it acquires the machine, would be as follows:
|
year
|
revenue
|
Expenses (excl.depr.and int.)
|
|
1
|
$2000,000
|
$1,529,000
|
|
2
|
2,350,000
|
1,679,600
|
|
3
|
2,600,000
|
1,829,800
|
|
4
|
2,850,000
|
1,979,800
|
|
5
|
3,100,000
|
1,997,800
|
The new machine would result in an increased investment in net working capital of $44,000. At the end of 5 years, the new machine could be sold to net $50,000 before taxes.
The firm has a 9% cost of capital and is subject to a 30% tax rate. As noted, the company uses straight line depreciation method. Mr. "Great" Kid has actually prepared that analyses, but he need your opinion about this decision, on the basis of your comparison of their relevant cash flows, which alternative appears to be better? Of course he needs also your recommendation based on the calculation the initial investment, the incremental operating cash flow, the terminal cash flow, and the relevant cash flow associated with each of the alternatives.