Gadgets, Inc. incorporated and will begin operations on January 1, 2020. Its primary business is the manufacture and sale of gadgets. Because cash resources are limited, the company anticipates the need to have access to capital during the first year of operations and seeks to establish a line of credit with a local bank. The bank requires a complete operating and cash budget and pro-forma financial statements for 2020 as part of the loan application.

The following information and data are to be used in preparing the budget.

1)Gadgets, Inc. is a closely-held corporation. The original owners will invest an initial $150,000 (assume the initial cash funding occurs on January 1, 2020) to establish the corporation and are the only shareholders of the company.

2)Production equipment totaling $36,000 will be purchased on January 2, 2020 and put into immediate use. The equipment has an expected useful life of five years, with no salvage value. It will be depreciated using straight-line depreciation method.

3)The sole product is the Standard Gadget. Each unit requires four pounds of raw material. The cost of the raw material is $0.50 per pound. It takes six minutes of direct labor to produce one gadget. Direct labor employees are paid $18.00 per hour.

4)Monthly fixed and variable overhead and selling & administrative (S&A) expenses are estimated below. Fixed manufacturing overhead is allocated on the basis of direct labor hours.

VARIABLE FIXED

Manufacturing overhead (including depreciation) 30% of direct labor costs $20,000

Selling & Administrative Expenses $0.30 per unit sold $ 6,000

5)Gadgets will sell for $8.00 each. January sales are expected to be 8,000 units. Demand is expected to increase by 400 units per month until a level of 12,000 units per month is reached.

6)Gadgets, Inc.s inventory policy establishes the following required monthly ending inventory levels:

Finished Goods: Maintain an ending inventory equal to one-half of the following month's expected sales.

Raw Materials: Maintain an ending inventory quantity equal to three-fourths of the materials needed for the next month's production.

Work-in-Process: Assume the month-end inventory is zero.

7)All sales are made to established credit customers with credit terms of net 90 days. No sales discounts are offered for early payment.

Twenty percent (20%) of payments for credit sales are expected to be received in the first month subsequent to the month of sale. Another sixty percent (60%) of payments are expected to be received in the second month after the sale. The remaining twenty percent (20%) of payments are expected to be received in the third month subsequent to the sale. (As an example, if January sales are $10,000, the company expects to receive payments of $2,000, $6,000 and $2,000 in February, March and April, respectively.)

8)Gadgets, Inc. has a credit arrangement with its raw materials vendor and purchases all materials on account with a basic invoice term of net 60 days. The company receives NO cash discounts for early payment of invoices. Gadgets pays 60% of its raw materials purchases in the month of purchase. The remaining 40% is paid in the first month

subsequent to the purchase.

9)All other operating expenses will be paid in the month incurred.

10)The income tax rate is 24%. Estimated tax payments are made to the US Treasury on the last day of each quarter. Each quarterly payment is $5,000. Any balance due at year-end is recorded as a liability on the balance sheet. If taxes have been overpaid, the estimated refund is recorded as a receivable on the balance sheet.

11)The company requires a minimum ending monthly cash balance of $2,000 which must be reflected in the cash budget.

12)The proposed funding agreement with the bank is a line of credit of up to $100,000, effective January 1, 2020. The annual interest rate on the line of credit is 4%, payable on the last day of each month on the outstanding loan balance.

In any month that the cash budget indicates ending monthly cash balance less than the required minimum cash balance; the company will borrow against the line of credit an amount sufficient to bring the ending cash balance up to the required $2,000 minimum. If the ending monthly cash balance is greater than the $2,000 required minimum, the excess cash will be used to repay the outstanding balance. Borrowings and repayments throughout the year will be budgeted in increments of $100. However, the company will budget for a final December payment that will reduce the line of credit balance to zero. Borrowing and repayments will occur on the last day of the month (not affecting the month end calculation of interest payment due that day.)

EXERCISES:

Record answers to the following exercises in the Exercises tab of the worksheet:

Exercise 1.

Based on the original budget, briefly evaluate the strength of the company based on the projected net income and cash flows. If you were a creditor making the decision to extend the line of credit to this company, what information would you consider in making the decision to lend to Gadgets, Inc.?

Exercise 2.

What would the sales price need to be to maintain the required minimum cash balance without borrowing additional funds? Round the calculated unit sales price to the nearest cent (show as $xx.xx).

Assume that sales demand is unaffected by any change in per unit price. HINT:

Consider using Goal Seek tool (found under Data > Data Tools > What-if Analysis.

Exercise 3.

Perform a sensitivity analysis. You may modify your existing budget workbook directly, but you may want to save a copy of your original budget so you can compare the new results to the original.

Assume that the projected increase in sales volume occurs at a rate 500 additional units per month instead of the original 400 units and that demand will cap at 15,000 units of sales.

To support this level of sales, the company will need to increase fixed and variable selling expenses by 25%.

Save your modified budget (this is the file you will submit) and answer these questions:

Do you recommend making this change?

Include comments on how the change would impact net income, overall cash flows and financing needs for the year