CASE 1 Nuts Inc.

1Nuts Inc. manufactures salted nuts and other snacks, which are sold through wholesalers to department stores and other shops and directly to airlines and companies operating cruise ships. About 50% of sales are to British Airways and British Caledonian Airways and are paid for in pounds.

Sales are seasonal. The demand of wholesalers peaks at the end of the year (Thanksgiving and Christmas); high level of sales is also reached during the summer months, because of increased demand from airlines and the tourist industry. Sales drop off sharply in January and again in August and September, after which they start to build up again.

The budget officer of Nuts Inc., Sarah Feldstein, is attempting to estimate the financial needs of the company for the first six months of 1989. Unit sales for the last three months in 1988 were (in number of cartons)

October 100,000

November 150,000

December 200,000

Ms. Feldstein makes the following sales forecasts for the first half of 1989, expressed in terms of percentages of actual October sales:

January 50%

February 60

March 60

April 70

May 80

June 120

July 125

Collections in previous years have been erratic. But the collection procedure has been changed, and now customers must pay 20% of the total amount in cash immediately and 50% of the remainder in the month following the sale. 'The other half of the remainder is collected two months after the sale. The firm has negligible bad-debt losses.

Half a kilo of raw materials is needed to produce one carton of the final product. One-third of the raw materials are purchased in Gambia, West Mrica, and paid for in British pounds. Raw materials are delivered in the month prior to sale, but are paid for in the month after sale. Labor costs are 50% of the total cost of the product and are paid for in the month of sale. The profit margin for Nuts Inc. is 20% of sales before depreciation and interest expenses. Sales, administrative, and other expenses are 16% of sales and are paid for in the month of sale. All goods are manufactured in the month of sale, but a base stock inventory of finished goods worth $20,000 is held in addition to raw materials.

New shelling and roasting equipment with a twelve-year life and no salvage value will be delivered and paid for in May. The cost of the equipment, installed and ready to run, will be $144,000, on which depreciation of $1,200 will be charged at the end of June.

Semi-annual interest charges on $235,833 worth of long-term bonds (12% coupon) are due in March. There are 15,000 shares of common stock (par value $10) outstanding; they are traded fairly actively in the over-the-counter market, typically at between ten and eleven times earnings per share (EPS). Quarterly common stock cash dividends of $10,000 are paid in March and June. Income tax prepayments of $8,000 are made in March.

Cash on hand on December 31, 1988, is $60,000, and a minimum cash balance of $50,000 should be maintained. All short-term borrowing is repaid as soon as cash is available. The interest rate on short-term borrowing is 12%. All borrowing and repayments take place on the first day of the month. Interest payments are due the first day of the month following the borrowing.

Fixed assets (net) as of the end of the year have a book value of $200,000 with an average life of ten years. All depreciation is taken biannually on a straight line basis. The tax rate is 40% . Retained earnings at the end of 1988 were $84, 167. There were no accruals or notes payable.

Based on figures for 1988, Ms. Feldstein prepares a pro forma income statement for the first six months of 1989. She then prepares a cash budget for the first six months of 1989, indicating the estimated amount of excess cash or the estimated amount of financing required to maintain the $50,000 minimum cash balance.

When Ms. Feldstein presents her financial forecasts to the Vice President for Finance she learns that two additional one-year contracts with major American airlines are about to be closed. Each contract will involve monthly delivery of $10,000 worth of snacks and salted nuts, starting in the month of March. Both of the contracts will be settled in dollars.