Question

Assume ABC Company has asked you to not only prepare their 2017 year-end Balance Sheet but to also provide pro-forma financial statements for 2018. In addition, they have asked you to evaluate their company based on the pro-forma statements with regard to ratios. They also want you to evaluate 3 projects they are considering. Their information is as follows:

End of the year information:

Account	12/31/17 Ending Balance
Cash	50,000
Accounts Receivable	175,000
Inventory	126,000
Equipment	480,000
Accumulated Depreciation	90,000
Accounts Payable	156,000
Short-term Notes Payable	12,000
Long-term Notes Payable	200,000
Common Stock	235,000
Retained Earnings	solve

Additional Information:

• Sales for December total 10,000 units. Each month’s sales are expected to exceed the prior month’s results by 5%. The product’s selling price is $25 per unit.
• Company policy calls for a given month’s ending inventory to equal 80% of the next month’s expected unit sales. The December 31 2017 inventory is 8,400 units, which complies with the policy. The purchase price is $15 per unit.
• Sales representatives’ commissions are 12.5% of sales and are paid in the month of the sales. The sales manager’s monthly salary will be $3,500 in January and $4,000 per month thereafter.
• Monthly general and administrative expenses include $8,000 administrative salaries, $5,000 depreciation, and 0.9% monthly interest on the long-term note payable.
• The company expects 30% of sales to be for cash and the remaining 70% on credit. Receivables are collected in full in the month following the sale (none is collected in the month of sale).
• All merchandise purchases are on credit, and no payables arise from any other transactions. One month’s purchases are fully paid in the next month.

• The minimum ending cash balance for all months is $50,000. If necessary, the company borrows enough cash using a short-term note to reach the minimum. Short-term notes require an interest payment of 1% at each month-end (before any repayment). If the ending cash balance exceeds the minimum, the excess will be applied to repaying the short-term notes payable balance.
• Dividends of $100,000 are to be declared and paid in February.
• No cash payments for income taxes are to be made during the first calendar quarter. Income taxes will be assessed at 35% in the quarter.
• Equipment purchases of $55,000 are scheduled for March.

ABC Company’s management is also considering 3 new projects consisting of the purchase of new equipment. The company has limited resources, and may not be able to complete make all 3 purchases. The information is as follows for the purchases below.

	Project 1	Project 2	Project 3
Purchase Price	$80,000	$175,000	$22,700
Required Rate of Return	6%	8%	12%
Time Period	3 years	5 years	2 years
Cash Flows – Year 1	$48,000	$85,000	$13,000
Cash Flows – Year 2	$36,000	$74,000	$13,000
Cash Flows – Year 3	$22,000	$38,000	N/A
Cash Flows – Year 4	N/A	$26,800	N/A
Cash Flows – Year 5	N/A	$19,000	N/A

Required Action:

Part A:

• Prepare the year-end balance sheet for 2017. Be sure to use proper headings.
• Prepare budgets such that the pro-forma financial statements for the first quarter of 2018 may be prepared.

• Sales budget, including budgeted sales for April.
• Purchases budget, the budgeted cost of goods sold for each month and quarter, and the cost of the March 31 budgeted inventory.
• Selling expense budget.
• General and administrative expense budget.
• Expected cash receipts from customers and the expected March 31 balance of accounts receivable.
• Expected cash payments for purchases and the expected March 31 balance of accounts payable.
• Cash budget.
• Budgeted income statement.
• Budgeted statement of retained earnings.
• Budgeted balance sheet.

Part B:

• Calculate using Excel formulas, the NPV of each of the 3 projects.
• It is possible that ABC Company may not be able to complete all 3 projects. Therefore, advise ABC Company as to the order in which they should pursue the projects (i.e., which project should ABC Company attempt to do first, second, and last).

Provide justification and analysis as to why you chose the order you did. The analysis must also be done in Excel, not in a separate document.

Answer 1

(PART: B)

     NPV (Net Present Value) = Sum of Discounted cash inflows- Sum of Discounted cash out Flows

COMPUTATION OF NPV OF PROJECTS:

NPV of Project: 1
Year	Cashflows	Required rate of return @ 6%	Discounted Cashflows
1	$48,000.00	0.9434	$45,283.02
2	$36,000.00	0.8900	$32,039.87
3	$22,000.00	0.8396	$18,471.62
4	$0.00	0.7921	$0.00
5	$0.00	0.7473	$0.00
Discounted Cashflows	$95,794.51
Discounted Cash Outflows	$80,000.00
NPV	$15,794.51

NPV of Project: 2
Year	Cashflows	Required rate of return @ 8%	Discounted Cashflows
1	$85,000.00	0.9259	$78,703.70
2	$74,000.00	0.8573	$63,443.07
3	$38,000.00	0.7938	$30,165.63
4	$26,800.00	0.7350	$19,698.80
5	$19,000.00	0.6806	$12,931.08
Discounted Cashflows	$2,04,942.28
Discounted Cash Outflows	$1,75,000.00
NPV	$29,942.28

NPV of Project: 3
Year	Cashflows	Required rate of return @ 12%	Discounted Cashflows
1	$13,000.00	0.8929	$11,607.14
2	$13,000.00	0.7972	$10,363.52
3	$0.00	0.0000	$0.00
4	$0.00	0.0000	$0.00
5	$0.00	0.0000	$0.00
Discounted Cashflows	$21,970.66
Discounted Cash Outflows	$22,700.00
NPV	-$729.34

Here, Project-1 and Project -2 have positive NPV's. Project-3 has Negative NPV.

Hence Project -3 should be Rejected.

Only Project-1 and Project -2 should be accepted.

In order to determine which project should be completed first, we need to do capital rationing.

CAPITAL RATIONING: Whenever there is scarcity of the amount of funds that can be invested during the specific period of time then we should do capital rationing.

If our objective is maximisation of profits, then use NPV method. But here our objective is maximum utilisation of fund, then we should use profitability index.

PROFITABILITY INDEX = Discounted Cash inflows/ Discounted Cash outflows

Profitability Index
Project	Discounted Cash inflows	Discounted Cash Outflows	PI=D.Cash inflows/D.Cash Outflows
Project-1	$95,794.51	$80,000.00	1.20
Project-2	$2,04,942.28	$1,75,000.00	1.17

So, Project -2 has higher PI, It should be completed First. Then only Project -1 Should be started.

So, Project -2 has higher PI, It should be completed First. Then only Project -1 Should be started.