Continuing with Toys-4-Kids introduced in the preceding problem, the company's production manager has argued for years that it is inef- ficient to produce on a seasonal basis. She believes the company should switch to level production throughout the year, building up finished goods inventory in the first two quarters to meet the peak selling needs in the last two. She believes the company can reduce its cost of goods sold from 70 to 65 percent with level production.

a. Prepare a revised pro forma forecast assuming level production. In your forecast assume that quarterly accounts payable under level production equal 10 percent of average quarterly sales for the year. To estimate quarterly inventory, use the following two formulas: Inventory Inventory + Quarterly production - Quarterly cost of sales Quarterly production Annual cost of sales/4 where eoq and boq refer to end of quarter and beginning of quarter, respectively. Please ignore the effect of increased external financing required on interest expense.

b. What is the effect of the switch from seasonal to level production on annual profits?

c. What effect does the switch have on the company's quarterly end- ing inventory? On the company's quarterly need for external fi- nancing?

d. Do you think the company will be able to borrow the amount of money required by level production? What obsolescence risks does the company incur by building up inventory in anticipation of fu- ture sales? Might this be a concern to lenders?

AppendixLO1