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I need help with questions 9 & 10. FINANCE EXPERTS ONLY. CASH FLOW CONCERNS Three months...

Question:

CASH FLOW CONCERNS Three months ago Harding had prepared a cash flow forecast for the period October 1995 to May 19%. NovembeTHE ALTERNATIVES What will you do in the event of a cash shortfall? Purcell asks. Harding explains the options available. THis strategy is to be completely open with the purveyors about Deerparks financial plight and ask for a deferment of some, iQUESTIONS 1. Should the resorts depreciation expense of $30,000 per month be consid ered in your cash budget? Explain 2. PreCASE 15 DEERPARK 93 EXHIBIT 1 Sales Forecast October-March Month Sales (000s) October 1995 November $609.5 370.3 December 257

i need help with questions 9 & 10. FINANCE EXPERTS ONLY.

CASH FLOW CONCERNS Three months ago Harding had prepared a cash flow forecast for the period October 1995 to May 19%. November through March is generally a slow period for the resort, and it is not unusual for the lodge to run cash deficits during most, if not all, of these months. However, the cash surplus generated during the peak period, from August through October, is typically sufficient to meet the shortfal. This is precisely what Harding had predicted would occur when he had made the cash budget projection in July. But now, in early October, he is having second thoughts about the forecast Three factors concern Harding. First, the renovations planned for January need to be more extensive than originally thought. Harding had estimated the cost to be $420,000, but it appears $500,000 of work is necessary. Second, the resort's long-time sales manager left unexpectedly in August and her replace ment does not seem to be as effective in obtaining convention business. Third, a recession has hit much of the area and Deerpark's sales are definitely sensi tive to the state of the regional economy. All this suggests Harding's sales forecasts, which he had labeled "conservative" in July, are too high. "I can see indications of this now," he tells Purcell. "Revenue is off 10 percent for September and October, and our advance bookings for the rest of the year are also down. I'm sure we won't hit the levels we predicted." Harding has always been an advocate of cash budget forecasts and constantly revises an estimate in light of new information. There is no doubt a new projection is necessary.
THE ALTERNATIVES "What will you do in the event of a cash shortfall?" Purcell asks. Harding explains the options available. The resort could postpone or reduce the renovations, delay accounts payable, ask the owners for additional money, arrange a loan with the resort's bank, or use some combination of these options There are problems with most of these alternatives, however. If the renova tions are not made in January, sales will likely suffer in future months; the resort is showing signs of wear, and it is important to alter the hotel's decor periodi cally. And, of course, the renovations are best made during an off-peak month like January. Further, the ownes at a recent mecting had made it clear that it would be "extremely difficult, if not impossible" for them to raise capital at this time. Nor is the prospect of a loan an appealing option. Relations with the bank have been strained since the resort nearly went bankrupt a few years ago, before Harding's arrival as manager. The bank, assuming it would grant a loan is likely to impose severe restrictions on the operation of the resort. That would be interference that neither Harding nor the owners would welcome. Harding's most attractive option is to delay accounts payable with the other alternatives used if needed. He intends to call a meeting of all Deerpark's purveyors and explain the situation
His strategy is to be completely open with the purveyors about Deerpark's financial plight and ask for a deferment of some, if not all, payments until April In return he will promise to pay COD when business picks up. "They just might agree to this," he tells Purcell. "We've been a good customer, and it is in their interest to help us out. After all, it's not like we're in danger of bankruptcy Reservations for next April through September are extremely strong, and we should be rolling in cash by early summer. In any event, we've got to do another forecast. I must know how bad the situation is. Do I ask them to post- pone 50 percent of what we purchase, 75 percent, 100 percent? I'm not even sure a complete deferment will be enough." Harding then asks Purcell to prepare a cash budget for October through March. He hands Purcell a revised estimate of sales (see Exhibit 1) and reminds Purcell that sales in September were $448,000. Typically, 70 percent of the resort's sales are paid in cash and 30 percent are paid using the resort's Deerpark Charge and collected in the month following the sale. Deerpark also incurs the following monthly expenses: mortgage, $50,000; utilities and maintenance, $70,000; and lease, rental, and miscellaneous expenses, $25,000. Property taxes of $107,000 are due in February, income taxes of $5,000 are due in December and March, and the renovations will be paid for in January. Exhibit 2 shows the resort's estimated payroll and purveyor expenses. Half of the purveyor expenses are paid one month after they are incurred and half in two months. Deerpark's required minimum cash balance at its bank is $100,000, and the current balance is $550,000
QUESTIONS 1. Should the resort's depreciation expense of $30,000 per month be consid ered in your cash budget? Explain 2. Prepare a cash budget for the period October through March 3. Is there any advantage to extending the forecast through April and May? Explain 4. Let's assume Deerpark's cash flow would not be sufficient to cover any shortfall occurring during the October through-March period. What amount of payables must be deferred to get the resort through this period? 5. Harding in essence will be asking the firm's vendors for a loan. Frm Deerpark's point of view, the size of the loan is your answer to question 4 From the suppliers' point of view, however, the size of their investment in the loan is actually less than that amount. Explain why. (Hint: The price charged will reflect the suppliers costs plus profit, and costs are the sum of fixed and variable costs) 6. Do Deerpark's purveyors have an incentive to cooperate? Explain 7. If the purveyors are unable or unwilling to cooperate, how do you think Harding should proceed? 8. Which do you think is more likely to revise a cash budget: a firm like Deerpark or an electric utility? Explain 9. What do you think is the most important variable in a cash budget forecast? Why? 10. Do you think that a cash budget is a more important financial tool for a small firm like Deerpark or a large firm like Exxon? Explain
CASE 15 DEERPARK 93 EXHIBIT 1 Sales Forecast October-March Month Sales (000s) October 1995 November $609.5 370.3 December 257.4 January 1996 February 178.2 202.4 March 288.2 Note: September sales were $448(000) EXHIBIT 2 Forecast of Payroll and Purveyor Expenses Purveyor (000s) Month Payrol (000s) 103.5 October 1995 163,3 November December 120.7 966 112.2 50.6 57.2 January 1996 February 82.5 85.8 82.5 100.6 March 99.0 Note: Purveyor expenses were $140(000) in August and $120(000) in September

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Answer:-

Q 9)

The most important variable in cash budget forecast is sales. The sales of the company primarily decides how much cash is required for the company to produce the goods. The estimation of sales helps the company in allocating the budget that is required to purchase the raw materials and maintain the inventory levels that is required to meet the demand for the product.

The sales projection should be done keeping in view the demand and the business cycle. The recession or slowdown leads to lower the sales.  The company should monitor the business cycle especially if its a cyclical business where the demand fluctuates if the production time taken is high ie the time taken to convert raw materials to finished goods. This will also help the company to maintain the inventory levels at all the three levels of raw materials, work in process and finished goods.

Q 10)

Th cash budget is more important financial tool for Deerpark than Exxon as the smaller the scale of the company the more important it is to manage the cash budget.The smaller companies have to meet short term obligation and liquidity needs and it becomes difficult sometimes when there is lower access to funds during periods of credit tightening from banks and lenders during recession.

As the bigger companies like Exxon have more access to funds ie.

They can raise funds easily by borrowing loans from banks, issuing commercial papers if they have good credit rating and tapping the market via IPO ( Initial public offer) or FPO ( follow on public offer) ie. via primary sale or secondary sale. The larger firms can also borrow funds externally to meet their financial needs.

The options for raising capital for smaller firms like Deerpark are lower compared to larger firms like Exxon. The smaller firms are more vulnerable to the business cycle and during recession there are lot of chances that the company may be adversely effected and face bankruptcy because there are more chances that the profitability will come down due to lower sales and lower margins. The smaller firms are also susceptible for ratings downgrade which increases the cost of borrowing which rises the interest expense leading to lower net profit.

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