Applied Corporate Finance

A-Z Toys Case

The most recent financial statements for A-Z Toys are contained in Exhibit 1.Suppose that the controller has decided to seek out a term loan, which proceeds could be used to repay $294,000 of the firm's short-term notes.The particular note in question was due in March of the coming year.Part of the needed funds was expected to come from operations and another portion from the sale of fixed assets during January for $95,000 (accumulated depreciation on the assets is $155,000, while the original purchase price was $250,000).

In addition to paying off the short-term note in March, the controller felt the firm should increase its cash balance to a minimum level of $50,000.The controller hoped to be able to hold out with the firm's existing cash balance, $10,000, plus cash flow from operations, until March, when he intended to seek the long-term loan.The proceeds from the loan in conjunction with funds from operations would be used to clear up $294,000 in notes payable and reach the desired cash balance.

Sales estimates for the next seven months, as well as past monthly sales for the previous three months are presented in Exhibit 2.

Traditionally, A-Z's sales have been 60% credit and 40% cash.Of the credit sales, roughly half are collected one month after the sale and the remainder collected two months after the sale, with negligible bad debt losses.Purchases are approximately 75% of sales and are made one month in advance, with payment following in 60 days.Variable cash operating expenses (including selling costs, wages, advertising, and miscellaneous cash expenses) are 7% of sales and are paid in the month in which they are incurred.Fixed cash operating expenses are roughly $2,500 a month, with payment made in the same month.Taxes are paid quarterly (April for the quarter ended in March, and so on; assume of last year's taxes have not been paid.) based on estimated earnings for the quarter.Annual depreciation expense is $90,000 on the net assets remaining after the January 1, 2016 sale of fixed assets.Interest expense for the notes payable is 12% and is payable quarterly in March and June.Interest on the outstanding long-term debt is at a rate of 7.5% and is paid semi-annually in June and December.The term loan is expected to carry a 9% rate, with interest payable semi-annually beginning in September and the entire principal amount due in five years.

a.monthly cash budget for the first 6 months of 2016.

b. balance sheet and income statement for the quarter ended March 31 and 6-months ended June 30.(You will have two balance sheets, one as of March 31 and the other as of June 30.You will have two income statements; one for the 3-months ended March 31 and the other for the 6-months ended June 30.You DO NOT have to prepare monthly balance sheets and income statements)

c.Based on your answer to question a., how much should A-Z seek in additional long-term debt to pay off the $294,000 note and increase cash to $50,000 as of the end of March?

Exhibit 1

December 31, 2014

December 31, 2015

Cash

50,000

10,000

Accounts Receivable

200,000

120,000

Inventory

150,000

150,000

Total current assets

400,000

280,000

Plant and Equipment

1,500,000

1,978,000

Less: Accum. Depreciation

(500,000)

(560,000)

Net Fixed Assets

1,000,000

1,418,000

Total Assets

$1,400,000

$1,698,000

Accounts Payable

100,000

180,000

Short-term notes

200,000

394,000

Accrued Expenses

10,000

14,000

Total current liabilities

310,000

588,000

Long-term Debt

400,000

400,000

Common Stock $10 par

200,000

200,000

Capital Surplus

490,000

510,000

Total liabilities and net worth

$1,400,000

$1,698,000

Income Statement for Year Ended December 31, 2015

Sales *

$1,200,000

Cost of goods sold

900,000

Gross profit

300,000

Operating expenses:

Variable cash operating exp.

84,000

Fixed cash operating exp.

30,000

Depreciation

60,000

Total operating expenses

174,000

Net income before Int. & taxes

126,000

Interest

39,600

Net income before taxes

86,400

Taxes @ 30%

25,920

Net Income

$60,480

* - includes 60% credit sales

Exhibit 2

Sales data: 2015-2016

20152016 (projected)

October$100,000January$90,000

November$100,000February$90,000

December$150,000March$90,000

April$100,000

May$110,000

June$100,000

July$90,000