Toy World Inc

BY Aadithya S Priya (0004/51)

Aavpreet Kaur (0006/51) Agasthi Vijaya Harika (0020/51)

Amulya Gadipudi (4013/21)

a) What factors could Mr. McClintock consider in deciding whether or not to adopt the

level production plan?

Mr. McClintock must primarily look into the following 3 factors in concluding whether or not to go for the plan of level production: 1) Financing requirements under the plan of level production

Inventory accumulates and sales are much less than production during

the off seasonal months. Cash needs to be arranged for this purpose

2) If credit limit of $2 million is sufficient to cover financing need and if yes, whether bank will extend the credit limit and how the interests affect the overall profits

Though the COGS will be reduced from 70% of sales to 65.1% of sales, the

operating expenses go up by $10,000 and the storage costs go up by

$115,000 and are needed to be considered.

3) Risks involved in the level production plan with respect to operations.

b) What savings would be involved?

When we compare the proforma statements of level and seasonal production, we can easily observe the following cost savings:

a) Over time premiums = 225000$ b) Other labour savings = 265000$ Total labour savings = 225000$ + 265000$ = 490000$

The above labour savings can be found out from the difference in the values of COGS in both the seasonal and level plans, which is

7000(in thousand dollars)-6510(in thousand dollars) = 490000$ Let us look at the increase in costs. c) Increase in storage costs = 115000$

The above can be obtained from the difference of values in the seasonal and level proforma statements i.e., 2515 (in thousand dollars) and 2400 (in thousand dollars) Total increase in costs = 115000$ The total net pre-tax savings would be = 490000$ - 115000$ = 375000$ Tax@34% = 0.34 * 375000$ = 127500$ Net Savings = 375000$ - 127500$ = 247500$ *The above calculations are done ignoring the changes in the interest income and

interest expense.

3. Prepare the pro forma financial statements and estimate the external funding needs Required. Income Statement Changes made:-

Reduction of COGS under level production from 70% to 65.1%

Additional operating expense of $115000/year due to high storage and handling cost

Annualized rate of return on average monthly cash balances – 4%

Interest rate on short term debt taken as 9% and long term debt taken as 9.625% Total net income of $644000 for 1994. Balance Sheet

Specific tax schedule followed to arrive at the accrued tax.

beginning inventory plus finished goods completed less cost of goods sold determined each month’s ending inventory (dividing the annual COGS by 12)

Notes payable used to assess the company’s additional funds required. External Funding Needs

Toy World Inc. will require large external funding in order to support inventory levels leading up to the holiday season. Toy World currently has a $2 million line of credit with the bank. In order to support the level production plan, an estimate is that Toy World will need a line of credit of close to $4 million in the month of September.

4) Compare the liabilities patterns feasible under the alternative production plans. What implications do their differences have for the risk assumed by the various parties?

Under the alternative production plans Toy world would have different timings and amounts of funding for inventory predictions. Under the seasonal production plan management would not take further loan and the months of September-December would witness a lower cash balance. If the predictions of demand for toys is not as expected then it would pose risks for the firm. They would have to decide between maintain the excess inventory till demand rises back or dispose it to save the holding costs and increase the working capital.

This decision is risky because if on disposal the demand rises, they would have a high opportunity cost and wouldn’t be able to satisfy the demand. On the other hand if they maintain inventory and the demand doesn’t rise, it would result in unnecessary costs and a loss in working capital. Since there is a high competition in the industry resulting from low trade barriers, taking huge amounts of loans is unadvisable and risky as a result of the huge company failures.