Preparing a Cash Forecast for a Company in Distress

Royal Company has incurred substantial losses for several years and is insolvent. On March 31, Year

5, Royal petitions the court for protection from creditors and submits the following balance sheet:

ROYAL COMPANY

Balance Sheet

March 31, Year 5

Book Value Liquidation Value

Assets

Accounts receivable.................................... $100,000 $ 50,000

Inventories.................................................. 90,000 40,000

Plant and equipment .................................. 150,000 160,000

Total assets ................................................ $340,000 $250,000

Liabilities and Stockholders Equity

Accounts payablegeneral creditors......... $600,000

Common stock ............................................ 60,000

Retained earnings ....................................... (320,000)

Total liabilities and equity .......................... $340,000

Royals management informed the court that the company developed a new product and a

prospective customer is willing to sign a contract for the purchase of (at a price of $90 per

unit) 10,000 units during the year ending March 31, Year 6; 12,000 units during the year ending

March 31, Year 7; and 15,000 units during the year ending March 31, Year 8. The product can be

manufactured using Royals current facilities. Monthly production with immediate delivery is

expected to be uniform within each year. Receivables are expected to be collected during the

calendar month following sales. Production costs per unit for the new product are:

Direct materials .................$20 Direct labor..............$30 Variable overhead .........$10

Fixed costs (excluding depreciation) amount to $130,000 per year. Purchases of direct materials

are paid during the calendar month following purchase. Fixed costs, direct labor, and variable

overhead are paid as incurred. Inventory of direct materials are equal to 60 days usage. After the

first month of operations during which Royal will order 90 days supply, 30 days usage of direct

materials is ordered each month.

Creditors have agreed to reduce their total claims to 60% of their March 31, Year 5, balances

under two conditions:

1. Existing accounts receivable and inventories are liquidated immediately with the proceeds going to creditors.

2. The remaining balance in accounts payable is paid as cash is produced from future operationsbut in no event

is it to be paid later than March 31, Year 7. No interest is paid on these obligations.

Under this proposal, creditors would receive $110,000 more than the current liquidation value of

Royals assets. The court engages you to determine the feasibility of this proposal.

Required:

Prepare a cash forecast for years ending March 31, Year 6 and Year 7. Ignore any need to borrow

and repay short-term funds for working capital purposes and show the cash expected to be available

to pay creditors, the actual payments to creditors, and the cash remaining after payments to

creditors.

(AICPA Adapted)