LITTLE ANNIN FLAGMAKERS BACKGROUND

Little Annin Flagmakers $($LAF$)$ manufactures one product, a large durable $8$ x $12$ American flag, which it sells for US$$120.$ Because of the large size of the flag, this product is not sold in stores; rather, it is sold through a relatively small number of on$-$line retailers. Each quarter, retailers estimate sales for the upcoming five months, revising proximate sales as necessary. In general, the retailers are reasonably good at estimating their sales needs; however, some variation in demand does occur and the retailers expect to be able to adjust orders as needed. LAF allows retailers to adjust each month$$s purchases to $80-120$ percent of the estimated sales levels. Flags are shipped to retail customers using JIT distribution so that the on$-$line retailers do not have to store inventory. Typical sales for the flag are $1,800$ units per month with seasonal increases April through August. Sales estimates are $2,500$ units in April, $6,000$ units in May, $3,000$ units in June, $2,500$ units in July, and $2,000$ units in August. Customers historically have paid $40$ percent of their purchases in the month of the sale, $55$ percent in the following month, and the remaining five percent is uncollectible.

MANUFACTURING AND SG&A COSTS

The flags are made in one plant which has a capacity of $6,200$ units per month. LAF budgets to have $20$ percent of next month$$s sales in finished goods inventory at the end of each month. There is plenty of storage space for finished goods. Fabric is the only direct material and each flag requires $5$ pounds of fabric at US$$7$ per pound. LAF plans to have $40$ percent of next month$$s fabric needs on hand at the end of the month. Fabric is purchased on credit with $40$ percent paid in the month of purchase and $60$ percent paid the next month. The standard direct labor hours to manufacture one flag is $0\mathrm{.}50$ hours at US$$40$ per hour. For simplicity, direct labor costs are budgeted as if they were paid when incurred. Manufacturing overhead rates are computed quarterly and applied based on direct labor hours. Fixed manufacturing overhead costs are estimated to be US$$57,950$ per month, of which US$$20,000$ is PPE depreciation. Variable manufacturing overhead, including indirect materials, indirect labor, and other costs, is estimated at US$$10$ per direct labor hour.

The selling and administrative expenses include variable selling costs $($primarily shipping$)$ of US$$1\mathrm{.}25$ per unit, and fixed costs of US$$63,000$ per month of which US$$10,000$ is deprecation of the administrative office building and equipment.

FINANCIAL STATEMENT DETAILS AND CASH PLANNING

LAF uses FIFO inventory valuation. As of March $31,$ the expected finished goods inventory is $410$ units, valued at US$$75$ per unit. The company expects to have $4,600$ pounds of fabric on hand, valued at US$$7$ per pound. Other expected account balances include: accounts payable at US$$55,000,$ accounts receivable at $132,000,$ cash at US$ $37,745,$ land at US$$520,000,$ and building and equipment at US$$1,800,000$ with accumulated depreciation of US$$750,000.$ LAF has no long$-$term debt; common stock is valued at US$$500,000$ and is not expected to change during the quarter; expected retained earnings as of March $31$ are US$$1,247,695.$

LAF budgets for US$$30,000$ ending cash balance each month and is requesting a line of credit that will allow it to adjust for its cash needs. The dividends of US$$15,000$ are paid each month. During the quarter, LAF planned to purchase equipment in May and June for US$$47,820$ and US$$154,600$ respectively. This equipment is being purchased to increase capacity and is not expected to come on$-$line until after the quarter, thus not affecting the manufacturing overhead costs.

LOAN DETAILS

LAF has requested a line of credit of US$$60,000$ to cover production costs during the seasonal increase in business. Kent Bank uses the following terms on its lines of credit. All borrowing is done at the beginning of the month, in whole dollar increments. All repayments are made at the end of the month, in whole dollar increments. The full line of credit is expected to be paid off by the end of the quarter with all of the interest repaid at the end of the quarter. The interest rate on this loan is $16$ percent per year.

Required:

$1.$ Using the data input provided in $($Exhibit $1),$ prepare LAF$$s master budgets in Excel. Do not hard$-$code numbers into the spreadsheet, except in the financing section of the cash budget.

$2.$ Conduct a sensitivity analysis, decreasing sales $2\%,5\%,$ and $10\%$ for April through August. New sales are provided in Exhibit $2.$ Adjust the financing and cash needs at these new sales levels.

$3.$ Determine a credit recommendation for Kent Bank, to lend or not. Be prepared to justify your credit decision.

$4.$ Explain why the cash budget is more important to a bank than the accounting net income when determining a credit decision.

$5.$ Explain why decreases in sales is examined in a sensitivity analysis for a credit decision.