TOPEKA ADHESIVES(I)
ne
This
case.
Case A b s t r a c t
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it
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owners relatlvely small b u n e want s a l e s growth e s t i m a t e ho much case also raises externally financed.
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policy.
Level
it
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slgnlflcant needed funds must issues about c r e d i t ex ec
Difficulty
Level
question
no
as
g ne d
Numerical Uniformity estimate
questions given
1-9, only a c c r u a l s must h e s tu tu d e n t s , t h e n
unique numerical answers. Q-10, d i f f e r e n t a ns n s w er e r s d ep e p en e n di di n Suggestions
Reducing
Q-10 s h o u have t r o u b l e
p ro ro ba b
estimated. t h e s e q u e s t i o n s have generate credit question,
assumptions used.
Case's Difficulty omitted. 5-a.
addition,
s t u d e n t s ma
I n s t r u c t o r ' s Note
with.
Topeka ( I I ) composite
used independently
issues
faced
this case. f i r m s t h a t we
case familiar
ANSWERS
w it h "cash
Davidson c o n f u s i n g " r e t a i n e d e ar n n g s balance sheet Retained earnings amount cash' available spend. p r o f i t s which "running t o t a l " firm. 1996
b e s t viewed reinvested
($000)
Forma
$1,933.1 1,333.8 599.3 441. 63.2 94.4 10.0 84.4 33.8 $50.6
Sales
Cost Goods S o l d Gross P r o f i t Administrative Costs
Depreciation EBIT Interest EBT
Taxes(40%) Income
each item.
rationale
Here's
hand."
indicate
-The s a l e s e s t i m a t e given. -Gross p r o f i t predicted n t o f sales. N o t e t h a t S h a t n e r ' s o r i g i n a l 32 p e r c e n t e s t m a t reduced.
sales l e s s gross p r o f i t . increase -Administrative costs estimated 20 percent. $34.0 -Depreciation 1995 a m o u n t , p l u s o n e 1996 p r e d i c t e d s p e n d i n g sixth $175, plant,
-CGS
land
equipment. -Interest assumed
o v e r a l l ACP average collection period, c u s t o m e r s who r e c e i v e t e r m s c o l l e c t i o n p e r i o d , ACP45,
ACP30 ACP45
he " o v e r a l l ACP" e q u a l s
Receivables 1996 i n $173.2
weighted average ACP30,
wh
those
average receive terms
32 d a y s
days
.40(32)
.60(46)
40.4 days
-.
($1,933.1/360) .
;
~
'
40.4 :
$216.9(000).
i . e . , "ending inventory," estimated $ 1 3 3 3 . 8 / 7 . 7 s i n c e i n v e n t o r y t u r n o v e r (CGS/INV)
v e n t o r y ~
estimated
call
.20(40) .10(55)
.80(30) .90(45)
......
(see case).
remain constant
7.7.
,,1
0.-:1
CGS
2/3*30
1/3*10
Accounts Payable We
'?'
B e g i 7 n i n g( ~ v e n t o r y Ending Inventory $1,333.8 $173.2 $149.5 $1,357.5(000)
Purchases Purchases Purchases APP
l t r ~
will
information a v e r a g e d 2.2%
23.33 days
23.33*($1,357.5/360)
estimate a c c r u a l s . Using accruals have Exhibit Exhibit 1993-95 p e r i o d . sales during
LIABILITIES
ASSETS
Cash
Receivables Inventory Other Current Total Current
$87.9(000)
$58.0 216.9 173.2 $459.7
(Accumulated
(188.7) 252.4 Fixed Assets $712.1 Total Assets
depreciation)
Accounts Payable Accruals D e b t -Due Total Current
NW
$87.9 42.5 20.0 $150.4
Long-Term D e b t stock
Common
Retained Earnings F un d
To
N ee de d Li
60.0 110.0 215.5 176.2 $712
..
rationale each item. sales. -Cash predicted percent - R e c e i v a b l e s were c a l cu la te d Q3-b. - I n v e n t o r y turnover (CGS/inventory) estimated 7.7. i n v e n t o r y estimate $1333.8/7.7 Thus $173.2. - O t h e r c u r r e n t a s s e t s a r p r e d c te d percent
Here's
sales.
-Gross fixed
$266.1
(1995 t o t a l )
p l u s $175,
p r e d i c t e d 1996 c a p i t a l s p e n d i n g . -Accumulated d e p r e c i a t i o n $ 1 2 5 . 5 (1995 t o t a l ) plUS $63.2, 1996 amount. case. given -Debt 1995 amount, l e s s d e b t debt -Long-term $80, $20. -Retained earnings $ 1 6 4 . 9 , t h e 1995 BS t o t a l , p l u s dividends e s t i m a t e d 1996 $50.6 income paid) will " p l u g " o r b a a nc in g i t e m -Funds needed
forecast.
balance sheet indicates t h a t $176.1(000) s h o r t a s s e t requirements. financing
estimated sources projected
77
I nv e n to r
1994
inventory
as 1993, 7.2, using t h i s average
(CGS/INV)
t ur n o v e
1995.
predicted
1996
(=1333.8/7.2). This $ 1 2 . 1 ( 0 0 0 ) more t ha n e s i m at e above (see 6 - a ) . Thus " f u n d s n e e d e d " w i l l higher but, r e a l l y , l a r g e amount.
s a l e s . Spontaneous l i a b i l i t i e s , sales. accruals, 5.3% 2.3% p r e d c te d sales ar dividends will 1996. Since e . a l e s method p r e d i c t s t h a t 1996
1995 a s s e t s 29.6% a cc ou n p ay ab l i.e. p r o f i t margin increase $386.6(000) paid,
funds
percent $4 needed w i l l
..
4(000),
shown b e l o w .
{'
.,
Funds Needed F un d N e e d
( ~ 2 9 6
93.9 ,\
.053)*$386.6 - . 0 ~ $49.4(000) 44.5 _\
L_
-),1_'
r.
3 * $ 1 9 3 3 . 1 ·
\l.,
s a l e s method a s s u m e s t h a t a s s e t s , income constant period. These h e f o r e c a s ti n Topeka conditions clearly hold here, experiencing s i g n i f i c a n t changes working c a p i t a l f i x e d a s s e t r e q u i r e m e n t s . Note t h a t 1996 a s s e t s estimated 36.8% sales spontaneous liabilities ar sales. p r e d c te d 6.7% percent
spontaneous l i a b i l i t i e s , p e r ce n t ag e o f 'sales over
addition, debt due.
that
s a l e s method d o e s n o
percent
things considered, ma es
Let's calculate Percent return
Return
there
will
retUJrn from t a k i n g discount
100-discount 2/98
360/(30
reason similar.
c on s d e
suppose
discount. _-:--_--=3::..;6:..0:..Final date d is co u n t p e ri o
36.7%
discount, before-tax return 36.7 percent W h i l e we d o n ' t know T o p e k a ' s c o s t funds, t h i s current strikes very hi9h return r e l a t i v e h i s t o r i c a l US s t a n d a r d s . T a k i n g t h d is co u n t t h e r e f o r e , looks like w i s e f i n a n c i a l move.
By t a k i n g
earned.
relevant choice Note t h a t w h i l e g r a n t i n g 45 d a y s 1: p a y , credit. and, t h u s , extending
b e t w e e n making t h i s s a l e sale making
Let's
equals
f i r s t assume t h a t
o n l y v a r ia b
CGS
c os t
1996 e s t i m a t e ( s e e Q - 2 ) . incremental a f t e r - t a x p r o f i t Topeka would
69 p e r c e n t '
$31,000*.6
$100,000*.31*.6 "'If"r;
- s ~ l e s . , - ' - t h e
$18,600.
/.1-"
i n c r e m e n t a l a s s e t requirements, assuming excess capacity, will h e a dd i o na l investment receivable:;
and, p e h ap s
'i
AR*(1-.31)
Asset requirements 'J
/'1 r',.
-.
.... I·./.
-!
,/",,'1
n v e n o ry .
~ ' l f '
~ ! I "
~.;'
INV/'",
$100,000*.69/7.7 $17,586
$ 1 0 0 , ~ 0 0 / 3 6 0 * . 6 9 * 4 5
8,961
8,625
11
T e c h n i c a l a c c u r a c y r e q u i r e s t h a t we a d j u s t t h i s spontaneous l i a b i l i t i e s . change
sideooint:
need which depends Now
capital cost
estimate
decision,
capi.tal funds t i e d inventory. This i s n ' t given, b u receivables than costs will "reasonable" gu he funds cost after-tax profit. instance, suppose high. almost surely percent, figure that $3,517. capital cost $17,586*.20 gain Topeka from t h i s s a l e follows.
Gain
3,517
$18,600
$15,083.
w i t h t h e s e a s s u m p t i o n s , w e ' d recommend t h a t T ~ p ~ k a sale. days cr ed i t rather than
e'xtend4'5
rfhe d e c i s i o n "disclaimer," though. grant this p r e c e d e n t t h a t Topeka e x t r a 15 d a y s c o u l d won't like. t h i s c u s t o m e r weaken will "giving T o p e k a ' . s b a r g a i n i n g power w i t h o t h e r c l i e n t s ? e ff ec ts " t h a t need p o e n a l " s pi l o v e there a r considered. We
have
a s s u m e t h a t Topeka excess c a p a c i t y which implies that f i r m ' s "overhead" must rncrease 'salle Q-2, 1996 indicates that administrative made.
No
let's
r o u g h l y 23 p e r c e n t costs sales, then proportional (100,000*.31
about
Q-6,
consider
no
1996
BS
pe en sales. sales, proportional
Asset requirements We
these costs
incremental a f t e r - t a x p r o f i t $4,800. 100,000*.23)*.6
Asset requirements must assets.
sales.
p r e v i o u s l y assumed
$17,586
he
shows t h a t Assuming
fixed n c r ea s fixed assets fixed assets
.13*100,000
percent cost
$30,586. capital
79
this sort.
then
capital cost exceeds .20*30,586 expected a f t e r - t a x $6,117 profit. Of c o u r s e , t h i s percent figure almost surely funds However, "high guesstimate." cost be), then granting (which above 4,800/30,586 ma t h i s f i r m 45 d a y s there good d e a l e v e n p o te n ti a s p i l o v e r e f f e c t s . decisions
e ca u we r e l a t i v e l y s im p analysis offers a s s u m e d t h a t Topeka w i l l sale unless terms he i s s u e becomes t r i c k i e r there sale terms some c h a n c e 'making that c a s e , we m u s t e s t i m a t e sale making probability incorporate t h i s these terms nt h e a n a ly s Sidepoint
