Question 12 Background Carmen Diaz has successfully translated her passion for sewing into a growing business. A couple of years ago, with a $10,000 loan from her cousins, she launched "Ribbons and Bows, a shop selling decorative ribbons and other sewn goods. As her revenue began to grow, she managed the business in a careful and conservative way, choosing not to pay herself a salary until she had paid off her debt to her cousins. By the fall of 2011, she had grown her busines to around $5,000 per month in sales, was debt free, and produced Net Income of around 20%. At the end of Sep, 2011 Ribbons an' Bows had the following Income Statement and Balance Sheet As of: Sep 30, 2011 Income Statement Period: July 1 thru Sep 30, 2011 Assets Liabilities & Equity Sales Cost of Sales $14,650 $6,500 $B.150 SE.190 100.0% 44.4% 55.6% Current Assets Cash & Equivalents $4,200 Gross Profit Accounts Receivable Less Allowances for Bad Debts Current Liabilities Accouts Payable Accrued Payroll Other Accrued Uabilities Income Taxes Pavable Nates Payable to Banks, Short-Term Current Partion of Long-Term Debt $0 SO 838 $760 Operating Expenses R&D Sales & Marketing General & Administrative $4,450 Tatal Operating Expenses $5,210 Operating Income $320 Total Curret Liabilities $2,940 20.1% Inventory Supplies Work in Process Finished Goods $6,200 $5,520 Other Income & Expenses Income Before Taxes 50 Long-Term Liabilities Lease (Purchase) Contracts Long-Term Debt (other than leases) Loans from Stockholders $2,940 20.1% Prepaid Expenses $ Income Taxes Ignored $2,940 NA Total Current Assets $10,720 Net Income Earnings per Share Less Current Portion of Long-Term Debt Total Long-Term Liabilities Fixed Assets Land & Buildings Machinery & Equipment Computers & Office Equip 8 Total Liabilities $2,050 $2,000 $4,050 -$2,010 $2,040 Less Accumulated Depreciation Total Fixed Assets Stockholders' Equity Capital Stock Contributed Capital Retained Earnings $1,000 $12,960 $1,200 Other Assets Deposits (held by others) Long-Term Investments Total Other Assets SO Total Stockholders' Equity $13.960 $1,200 Total Assets $13,960 Liabilities and Equity $13,960 After all her work, Carmen was finally at a point that she could consider paying herself a salary or an ongoing dividend out of future earnings. Just as she was contemplating this possibility, a businessman from Hong Kong came into her store with an offer for her to consider. He explained that he awned several merchandising stores around the Hong Kong area. He had seen her work, and had an idea for a design for a special Lunar New Year bow that he would like for her to make and supply to his store. He showed her the design he had in mind. It was quite involved and would require more labor and time at the sewing machine than most of her designs, but Carmen knew she could make them. Carmen was stunned when he offered a Purchase Order for $20,000 worth of the bows. The Purchase Order included the following terms and conditions: The bows would need to be delivered to his stores in Hong Kong no sooner than Dec 1st and no later than Dec 30th. He will pay 50% down, upon acceptance of the order. He will pay the balance of the order 30 days after the Lunar New Year (Feb 8th). He went on to say that if the bows were a hit, he felt the concept could be extended to a variety of seasonal holidays throughout the year in his stores, and that she could expect follow-on orders for different occastions each quarter. If this worked out, it could eventually tripple the sales volume of Carmen's business. In evaluating the status of her business, Carmen had just concluded that she was happy with the progress she had made, and looked forward to a nice and steady (although modest) income stream from the earnings it was producing. She felt this new opportunity was both exciting and risky. As such, she realized that one option was simply to turn down the businessman's proposal and proceed with her prior plans to run the business at it's current pace. But she felt compelled to evaluate her options to fulfill the order and potentially ramp her business before making a decision. As she studied this she developed 2 Scenarios to consider