2.What are total saving from adopting level production?

Premium and maintenance cost (+) / $ 480,000.00
Reduced hiring and Training cost (+) / $ 600,000.00
Increased Storage and Handling cost (-) / $ 300,000.00
Total saving / $ 780,000.00

3. Which factors should Mr. Weir consider in deciding whether to adopt level production?

Factors to be considered to decide whether to adopt level production or not:-

  • Under Utilization: Machinery stood idle for half of each year
  • Maintenance: Intensive use led to excessive maintenance costs.
  • Setup changes: Mass manufacturing of different styles and sizes resulted in frequent setup changes on the machinery.
  • Hiring and training new contract-based employees was costly.
  • Wage premiums due to overtime dramatically increased operating costs.
  • Time to adopt: When to adopt level production to minimize risk.
  • Storage cost: How the new production technique affect the storage cost.
  • Purchase terms: if it would be affected by the change in production scheduling.
  • Handling costs: How the new production technique affect the storage cost
  • Risk of product obsolescence
  • Prediction:of whichproducts would sell the best.
  • Burden of excess merchandise for those styles and colors that retailers had not purchased with level production.
  • Discounts:Styles that drew a poor market response
  • Effect on financing needs
  • Effect on profits, inventories, accounts receivable and accounts payable
  • Impacton funds inflows and outflows to avoid possibleviolations of Polar’s loan covenants.
  • The trade-off between the potential cost savings and the financial risks that the company might face
  • The implications of the switch for short-term financing needs.

4.Prepare pro forma income statement, balance sheets and cash flow statement to estimate the amount of funds required and the timing of the needs under level production. Does Polar need more than $4 million in short-term financing in any given month?

Ans: Refer to the excel file attached for the various financial statements. Polar requires> $4 million in Short-term financing if you see closely through the balance sheet (Working capital-cash) for September and October is more than $4 million.

5.Think about the concern of Polar’s bank. As the banker, would you be willing to extend the line of credit of more than $4 million to finance level production? Why or why not?

There are times in the year when the credit requirement is more than $4 million during 2012. According to covenant, the outstanding balance on the line of credit was not to exceed two-thirds of accounts receivable and inventory combined. And the credit requirement always remained less than the given condition. So if I were the banker, I would have been willing to extend the line of credit subject to a higher interest rate due to increased risk. The reason apart from the obvious would also include the long association of polar with the bank, its past track record of timely payment and also the positive outlook towards the future as suggested from the statements.

6.What other source could substitute in part for bank lending if the lender is not willing to extend the present line of credit?

Sources of capital

Long term

  • Share Capital
  • Mortgage loan
  • Retained Profit
  • Venture Capital
  • Debenture
  • Project Finance

Medium term

  • Leasing
  • Hire Purchase

Short term

  • Bank Overdraft
  • Trade Credit
  • Deferred Expenses
  • Factoring

Capital market

Long-term funds are bought and sold:

  • Shares
  • Debentures
  • Reserve funds
  • Euro Bonds
  • Law Firms

Money market

  • Credit on open account
  • Bank overdraft
  • Short-term loans
  • Bills of exchange
  • Factoring of debtors

7.Compare the liability patterns feasible under the alternative production plans. What implications do their differences havefor the risk assumed by various parties?

Case 1: Level Production / Jan / Feb / Mar / Apr / May / Jun / Jul / Aug / Sep / Oct / Nov / Dec
Accounts Payable / 232 / 160 / 137 / 125 / 53 / 59 / 125 / 178 / 980 / 832 / 1,889 / 1,170
Line of credit payable (working capital) / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 785 / 80 / 847
Accrued Taxes / 94 / 26 / -188 / -388 / -492 / -715 / -795 / -857 / -757 / -590 / -55 / 111
Long term debt. Current portion / 100 / 100 / 100 / 100 / 100 / 100 / 100 / 100 / 100 / 100 / 100 / 100
Current liabilities / 425 / 286 / 49 / -163 / -339 / -556 / -571 / -578 / 323 / 1,126 / 2,014 / 2,228
Long term debt / 1,000 / 1,000 / 1,000 / 1,000 / 1,000 / 950 / 950 / 950 / 950 / 950 / 950 / 900
Total Liabilities / 1,425 / 1,286 / 1,049 / 837 / 661 / 394 / 379 / 372 / 1,273 / 2,076 / 2,964 / 3,128
Case 2: Traditional approach
Accounts Payable / 450 / 450 / 450 / 450 / 450 / 450 / 450 / 450 / 450 / 450 / 450 / 450
Line of credit payable (working capital) / 0 / 0 / 0 / 70 / 1020 / 2192 / 3269 / 4319 / 4619 / 4819 / 2344 / 959
Accrued Taxes / 106 / 42 / -172 / -373 / -486 / -718 / -804 / -869 / -722 / -515 / 133 / 368
Long term debt. Current portion / 100 / 100 / 100 / 100 / 100 / 100 / 100 / 100 / 100 / 100 / 100 / 100
Current liabilities / 656 / 592 / 378 / 247 / 1084 / 2024 / 3015 / 4000 / 4447 / 4854 / 3027 / 1877
Long term debt / 1000 / 1000 / 1000 / 1000 / 1000 / 950 / 950 / 950 / 950 / 950 / 950 / 900
Total Liabilities / 1656 / 1592 / 1378 / 1247 / 2084 / 2974 / 3965 / 4950 / 5397 / 5804 / 3977 / 2777

Also from the excel sheet, you could see debt to equity and debt to total capital ratio. The ratios in the level production approach are more. So it is more risky in the new case.

8.What would be the impact of unsold inventory on cash flows and projected cost savings?

The various impacts of unsold inventory on cash flows and projected savings include:-

  • Storage and handling costs: As the unsold inventory is to be maintained. It results in inherent storage and handling cost till it is cleared off. So savings decreases and there is an extra expense to take care of.
  • There is a huge risk of product obsolescence: In high trend industries, customer preferences changes and if the company can’t keep up with changing interests of the customer, the old inventory can be soon out of fashion and its demand subsides. In turn the cash is blocked and hence result in decrease of cash flow as the liquidity of the unsold inventory is pretty low.
  • Burden from excess merchandise for those styles and colors that retailers had not purchased with level production: Thus in turn the profits and cash in hand decreases
  • Styles that drew a poor market response would be deeply discounted at the end of the selling season: Resulting in decrease of profits.
  • Account payable: As the inventory is unsold new relationships are to be fenced with the suppliers and account payable is unpaid for a longer period making more pressure on cash flow of the organization