ldexo Corporation is a privately held designer and manufacturer of licensed college apparel in Cincinnati, Ohio. In late 2016, after several years of lackluster performance, the firms owner and founder, Rebecca Ferris, returned from retirement to replace the current CEO, reinvigorate the firm, and plan for its eventual sale or possible IPO. She has hired you to assist with developing the firms financial plan for the next ve years.

In 2016, Idexo had total assets of about $103 million and annual sales of $100 million (see Table 1). The rm was protable, with expected 2016 earnings of more than $9 million, for a net profit margin of 9.1%. However, revenue growth has slowed dramatically in recent years and the firms net prot margin has actually been declining. Ferris is convinced the rm can do better. After only several weeks at the helm, she has already identied a number of potential improvements to drive the firms future growth.

Operational Improvements

On the operational side, Ferris is quite optimistic regarding the companys prospects. The market is expected to grow by 6% per year, and Idexo produces a superior product. ldexos market share has not grown in recent years because prior management devoted insufficient resources to product development, sales, and marketing. At the same time, Idexo has overspent on administrative costs. Indeed, from Table 1, Idexos current administrative expenses are $18 million/$100 million = 18% of sales, which exceeds its expenditures on sales and marketing (15% of sales). Competitors spend less on administrative overhead than on sales and marketing. Ferris plans to cut administrative costs immediately to 15% of sales and redirect resources to new product development, sales, and marketing. By doing so, she believes Idexo can increase its market share from 10% to 14% over the next four years. Using the existing production lines, the increased sales demand can be met in the short run by increasing overtime and running some weekend shifts. The resulting increase in labor costs, however, is likely to lead to a decline in the firms gross margin to 53%. Table 2 shows sales and operating-cost projections for the next five years based on this plan, including the reallocation of resources from administration to sales and marketing over the five-year period, and an increase in ldexos average selling price at a 2% ination rate each year.

Expansion Plans

Table 3 shows the forecast for Idexos capital expenditures over the next ve years. Based on the estimates for capital expenditures and depreciation, this spreadsheet tracks the book value of Idexos plant, property, and equipment starting from its level at the end of 2016. Note that investment is expected to remain relatively low over the next two yearsslightly below depreciation. Idexo will expand production during this period by using its existing plant more efficiently.

However, once Idexos volume grows by more than 50% over its current level, the firm will need to undertake a major expansion to increase its manufacturing capacity. Based on the projections in Table 2, sales growth exceeds 50% of current sales in 2019. Therefore, Table 3 budgets for a major expansion of the plant at that time, leading to a large increase in capital expenditures in 2019 and 2020.

Working Capital Management

To compensate for its weak sales and marketing efforts, Idexo has sought to maintain the loyalty of its retailers, in part through a very lax credit policy. This policy affects Idexos working capital requirements: For every extra day that customers take to pay, another days sales revenue is added to accounts receivable (rather than received in cash). From Idexos current income and balance sheet (Table 1), we can estimate the number of days of receivables as:

The standard for the industry is 45 days. Ferris believes that Idexo can tighten its credit policy to achieve this goal without sacrificing sales. Ferris does not foresee any other significant improvements in Idexos working capital management, and expects inventories and accounts payable to increase proportionately with sales growth. The firm will also need to maintain a minimum cash balance equal to 30 days sales revenue to meet its liquidity needs. It earns no interest on this minimal balance, and Ferris plans to pay out all excess cash each year to the firms shareholders as dividends.

Capital Structure Changes: Levering Up

Idexo currently has $20 million in debt outstanding with an interest rate of 6.8%, and it will pay interest only on this debt during the next five years. The rm will also obtain additional financing at the end of years 2019 and 2020 associated with the expansion of its manufacturing plant, as shown in Table 4. While Idexos credit quality will likely improve by that time, interest rates may also increase somewhat. You expect that rates on these future loans will be about 6.8% as well. Given Idexos outstanding debt, its interest expense each year is computed as:

Questions

Use the worksheet titled Projected Working Capital to project Idexos working capital needs over the next ve years. Why is the increase in net working capital negative in 2017? Why does the increase in net working capital decline from 2017 to 2018?

Projected Working Capital

Year				2016	2017	2018	2019	2020	2021
Working Capital ($000s)
Assets
Accounts Receivable				20,000
Inventories				8,219
Minimum Cash Balance				8,219
Total Current Assets				36,438
Liabilities
Accounts Payable				6,205
Net Working Capital				30,233
Increase in Net Working Capital