Corp Finance Solution

Toy World CEO has to resolve the cash budgeting problem. This problem involves the issues of the target cash balance, the optimal size of the credit line, the investment of excess cash, and production plan for a seasonal business.

Being proposed with a change to level production, Mr. McClintock has to think about following in deciding whether or not to adopt a level production plan:

A) What are financing needs under level production plan?

B) Will the current credit limit of $2 million be sufficient to cover financing need?

C) What are the risks involved in the level production plan.

Analyst response:

A)-B)

Financing needed for level production strategy is higher than seasonal production strategy. Notes Payables is higher than $2 million bank limit from June to November (June-$2.045mln; July-$2.67mln; August-$3.31mln; September-$3.97mln; October-$3.1mln; November-$2.07mln). In other words, bank limit renegotiation is needed if the CEO decides to shift to the level production strategy. Conclusion is, the company needs credit line of up to $4 mln to finance level production plan.

Advantages of the level production plan.

• Net income increases by almost 52% to $ 1.81 mln

• Toy World is almost operating at the full capacity during seasonal production peak. The change to level production schedule postpones the need for additional investments in fixed assets.

Disadvantages of the level production plan.

• Required bank loan from June to November is above the $2mln limit set by the bank. So loan terms have to be renegotiated.

• Risk