Proforma 1
A friend of yours (Kathleen) decides to start a retail photo store and has asked your help in
developing projected financial statements for the first five years. Her banker will not consider
making a loan without five year projections of balance sheets, income statements, and cash flows.
Kathleen will use the $100,000 she inherited from her grandfather to help start the business,
and she will borrow from the bank the remaining money she needs. She has found a location in a
shopping mall that will rent her space for $1,500 per month, and she estimates that utilities will cost
another $1,000 per month. Salaries and wages should cost approximately $5,000 per month, but the
total of these costs will rise another $1,000 per month as sales exceed $400,000 per year. Use an
income tax rate of 35%.
Sales will start at $250,000 for the first year, rise to $300,000 in the second year and
increase $50,000 per year thereafter. Gross margin will approximate 40% of sales.
Kathleen will have to spend $50,000 on fixtures and equipment, and she will depreciate
these assets over five years using the straight line method; all assets will have zero salvage value at
the end of their lives. She expects inventory to turn six times per year, and one-fourth of sales will
be on credit; the average collection period for stores like this usually is sixty days. All suppliers
expect payment for merchandise in thirty days.
Any money borrowed will cost 10% for interest.
Required:
1. Prepare proforma financials for the first five years of operation.
2. Tell how the statements would change if Kathleen had to borrow all the money she
needs to get started.
Proforma 2
Garth Jones plans to open an automotive repair shop in his neighborhood. He has scraped
together $75,000 by getting his mother and sister to invest in his venture. The rest of the money he
will borrow from a local bank that has encouraged him to apply for a loan. Garth found a great
building that he can rent for only $1,000 per month.
Garth expects sales to equal $100,000 in his first year, grow to $200,000 in the second year,
and grow by 10% per year after that. He expects half his sales to be paid in cash, and the remainder
will be paid with credit cards. Garth deposits credit card slips with his regular bank deposit, and the
bank credits his account with 95% of the face value of the slip.
All mechanics working in the garage will earn a commission of 50% of the service revenue
they generate, and the shop gets all the margin on parts sales (parts earn a margin of 50%). Parts
will equal 20% of sales, and Garth expects parts inventory to turn 12 times per year. Local
suppliers offer thirty day terms.
To conserve cash, Garth will rent some of his equipment for $2,500 per month, and he will
purchase another $120,000 of equipment when he opens the shop. He will depreciate this
equipment over its five year life using the straight line method. In year 3 he will purchase additional equipment for $75,000, and this will drop his equipment rental down to $1,500 per month.
Use a tax rate of 35%, and assume the bank will charge 10% for loans to Garth.
Required:
1. Prepare proforma financials for the first five years of operation.
2. Assume Garth did not use his mother and sister to raise his original $75,000. Instead he
got this money from some investors who want to earn a 20% return on their investment
after year 1 operations. They are willing to be stockholders or creditors, whichever
Garth prefers. Which form of financing should Garth use?
Proforma 3
You decided to start a business that will provide freight forwarding services to local
companies. By approaching your family and friends you raise $100,000 for startup capital. You
expect sales to start at $50,000 in the first year, rise to $120,000 in the second year, and reach
$300,000 by the third year. Sales will grow at an annual rate of 10% for the two years following
that year. You will earn a margin of 40% on your sales.
The freight forwarding business requires little investment because the freight forwarder
operates as a broker; the freight forwarder buys freight services at wholesale from airlines and
trucking companies (and any other form of transport) and sells the services at retail to businesses
who require the service. The business carries no inventory, and most costs go for salaries, rent and
communications costs. You expect these costs to be $75,000 in the first year and $100,000 in the
second year; you expect the costs to grow 5% per year for the remaining periods.
Your company will make all purchase and sales transactions on account. You expect to
collect for the freight services in 45 days, and you know the companies providing the service will
require payment in 30 days. Use a tax rate of 35%, and use an interest rate of 10% for any borrowings.
Required:
1. Prepare proforma financial statements for the five year period.
2. You studied companies comparable to this venture that are publicly traded and estimated
that a suitable beta for this new venture would be about a 5. What rate of sales increase
would you need in the last two years to make this a worthwhile investment?
Proforma 4
Jack Ball is considering expanding his video tape duplicating business. The current
financial statements for the past year are shown below.
Revenue
$8,000,000
Materials used
Labor
Freight and postage
Cost of Sales
4,000,000
760,000
240,000
5,000,000
Gross Profit
$3,000,000
Operating Expenses
Rent
Utilities
Sales people
Salaries--managers
Depreciation
Interest
Equipment maintenance
Advertising and promotion
Telephone
Total
Profit before taxes
Income taxes
Net Profit
$ 275,000
185,000
320,000
380,000
120,000
150,000
25,000
40,000
50,000
1,545,000
$1,455,000
509,250
$945,750
Balance Sheet
Cash
Accounts Receivable
Inventory
Other Current Assets
Total Current Assets
$675,000
1,288,000
405,000
4,000
$2,372,000
Equipment--net
Other fixed assets
Total Fixed Assets
Total Assets
700,000
25,000
725,000
$3,097,000
Accounts Payable
Bank Loans/Venture Capital
Other
Total Liabilities
$532,000
1,050,000
35,000
$1,617,000
Equity--Stock
Retained Earnings
Total Equity
Total Liabilities & Equity
280,000
1,200,000
1,480,000
$3,097,000
In order to expand at the rate he feels necessary to capture greater market share, Jack
estimates sales will have to grow at 10% per year. Because of problems in the past with his bank,
Jack wants to avoid borrowing more money if possible. He has approached leasing firms for
information about the cost of leasing the additional $5,000,000 in equipment he needs to expand the
operation. The leasing company that specializes in the type of equipment he needs will furnish all
the equipment for the expansion for 10% down and the remainder paid out over a five year lease
designed to return 15% before tax to the leasing company. The equipment will have a salvage
value equal to 10% of its initial price.
He has also considered getting an investor to invest $5,000,000 with a guarantee that the
investor will earn a 20% return on the investment with equal payments made in the last three years
of the five year period. By delaying the payments to the last three years Jack will be able to spend
another $50,000 on promoting sales in the first two years, and this will cause sales to rise by 12%
annually for the five years. The equipment will depreciate to zero at the end of five years.
Expanding the business will entail moving to a new location, so Jack estimates startup costs
in the first year will equal $750,000. All cost of sales items will remain at the same percentage of
sales as in the current income statement, and Operating Expenses will remain at their current levels
except for the following:
Rent will double
Utilities will increase by 25%
Managers cost will increase by 50%
Telephone costs will increase by 25%
All sales are made on account, and customers normally pay in 45 days. Inventory will turn
12 times per year, and accounts payable will be paid in 40 days.
As soon as the company generates profits, Jack wants to start paying one-half the annual
profits in dividends to the stockholders.
Use a tax rate of 35% in preparing income statements.
Required: Prepare projected financials for a five year period. Which equipment financing method
should Jack use to finance the $5,000,000 in equipment?
Proforma 5
A local behavioral health care company, Happy Health, has approached you for help in
developing projected financial statements. This company contracts with Health Maintenance
Organizations (HMO's) and insurance companies to provide psychological and psychiatric help to
individuals who need this service. The firm also provides "quality of life" services to individuals
who want to change aspects of their life related to interpersonal relations.
Contracts with HMO's pay a fixed amount per month (called a capitation fee) to Happy
Health for each person covered by a contract, and Happy Health must deliver as much service as
required under the contract with no additional fee. Some insurance companies pay on a fee for
service basis, e.g., the company collects $75 per hour of service delivered. Recently the company
has noticed more insurance companies requesting capitation contracts.
Most insurance companies pay their accounts in 60 days, but the capitation contracts
provide a steady monthly payment to Happy Health. At the end of the current year Happy Health
had a balance in accounts receivable of $120,000. Individual clients who pay their own fees pay
cash at each visit.
A typical client arranges an appointment with one of the clinicians at Happy Health, comes
in for the one hour visit and then either pays, completes insurance forms, or signs a simple form if
he or she is covered by a capitation agreement. Current annual revenues are approximately
$800,000, and Happy Health managers expect these to grow at 40% annually for the five year
period. The fraction of revenues from the different sources for the current year are:
Capitation agreements
Insurance
Individual pay
35%
45%
20%
However, these proportions will change over the five year period as follows:
Patient Type
Capitation Agreements
Insurance
Individual Pay
Year 1
35%
45%
20%
Year 2
40%
40%
20%
Year 3
45%
40%
15%
Year 4
50%
30%
20%
Year 5
60%
30%
10%
Happy Health pays individual clinicians 50% of the revenue they generate from private pay
patients and from insurance payments that pay on a fee for service basis. However, for capitation
patients, the company pays clinicians what they would have earned if the patient had been a private
pay patient. Through skillful negotiation strategies the company expects to sign contracts that will
allow it to maintain clinician costs at 50% of revenue for the capitation patients. Currently the firm
generates $65 of revenue per hour of clinical service on average, and the company expects this to
remain constant for the next five years. Each clinician sees patients for an average of 25 hours per
week for 50 weeks per year.
Every clinician added to the staff adds $1,000 in monthly costs for office space and other
related expenses. Every additional five clinicians causes the company to hire an additional staff
person at $30,000 per year for all benefits. Currently the company spends $20,000 annually for
office and related expenses, and it spends $200,000 annually on office staff. Assume these costs
will remain at this level for year 1. Other related administrative costs amount to $375,000 annually
and this will increase by $15,000 per year for the five year period.
Since most expenses are personnel costs and rent, assume all expenses are paid in cash in
the month incurred. However, assume an end of year current liability of $5,000 for various
miscellaneous items.
The owners have a current investment in the firm in the amount of $100,000 with an equity
from profits of $20,000. Because it is a medical practice, the firm is not established as a
corporation. However, for planning purposes the company computes an income tax expense each
year just as if they were actually a corporation. Happy Health plans to distribute profits of $250,000
to the owners (the equivalent of dividends) in each of years 4 and 5.
Required:
1. Prepare financial statements for the five year period.
2. How much could the rate of increase in sales drop before the practice had to borrow
money?
3. How much can the cost of monthly costs for office space and other related expenses
increase before the practice must borrow money?
4. Will the practice be able to pay the "dividends" it hopes to pay in years 4 and 5?
5. The firm has an opportunity to buy a practice for $200,000 that has ten clinicians
working in the practice. Assume the revenue mix from these clinicians will be similar to
the mix for the clinicians at Happy Health and that all expense relationships are also
similar. Show before and after financial statements to evaluate this purchase. Should
they make the purchase? How much would you be willing to pay for the practice?
Proforma 6
You are considering opening a restaurant (similar to Cracker Barrel, Ticker CBRL) that you
hope will serve as a model for a chain of restaurants serving the Southeastern part of the U.S. A
group of investors have assembled $1,000,000 of startup capital for your first facility. If the first
restaurant is a success your investor group plans to go public to raise the capital for an additional
twenty restaurants.
A search of possible locations turned up a building for lease in a strip mall close to a major
intersection that handles heavy traffic into and out of the main part of the city. The owner of the
building wants $10,000 per month for rent, or she is willing to take $3,000 per month plus three
percent of the monthly sales.
Food costs will average 35% of sales, and local suppliers will sell to you on account with
twenty day payment terms. Because it is perishable, you expect your food inventory to turn 50
times per year, and suppliers expect payment within twenty days. Labor costs for cooks and waiters
will approximate another 21% of sales, and advertising will add another 5% of sales to your costs.
Administrative costs should be no more than $25,000 monthly, and utilities expense will
equal another $5,000 per month; however, a small portion of utilities will vary with sales, an
amount you estimate to equal 2% of sales.
Starting up a high quality restaurant is no simple task, so you estimate startup costs in the
first year will equal $750,000, $150,000 the second year, and $100,000 the third year. Equipment
(which you will depreciate over five years assuming no salvage value) will use another $1,200,000
in the first year. A study of the experience of other restaurants revealed that breakage of dishes and
tableware will equal about 1% of sales.
Sales in the first year will only amount to $1,500,000 because you will spend the first six
months just getting the enterprise up and running. The second year should see sales of $3,000,000
with this rising another 50% in year 3. You expect revenue increases of 10% for each of the two
remaining years as you refine the restaurant concept. Of total sales, forty percent will be for cash
with the remainder paid with credit cards. Because of your size and potential sales volume, the
bank will take only a 2% discount from the credit card amounts, i.e., the bank will credit your
account for 98% of the face value of the credit card slips on the day you deposit the ticket in your
account.
You are very interested in the maximum dividends the company can pay as soon as it
acquires a positive balance in retained earnings, so you plan to seek this information from the
projected financials you prepare to evaluate this business idea.
In the beginning you expect corporate costs to be $250,000 for operating the first store. As
you add stores you expect these costs to rise by $200,000 per year for the next four stores, and to
rise by $150,000 for the next five stores after that.
Use a tax rate of 35%, and assume you can borrow money for 10%.
Required: Consider each question separately unless one question specifically refers to another.
1. Prepare financial statements for the five year period, and recommend a dividend policy.
2. Assume the company has five restaurants open that are all identical, all restaurants have
been open for more than three years, and the company replaces all equipment at the end
of five years. If the company has 2 million shares outstanding, what will its average
store sales have to be to generate a stock price equivalent to the current Cracker Barrel
stock price? Assume annual corporate expenses outside the individual stores will equal
$2 million.
3. Use question 2 information in answering this question. You decide to open a sixth store.
How much will sales for the first five stores have to increase in the year you add the
store to make average store profits the same with six stores as they were with five
stores?
Proforma 7
The following excerpt was taken from a business plan for a freight forwarding company
planned by Mr. Jerry Higgins, an entrepreneur who had developed a software program for tracking
the movement of freight shipments.
Summary: The Business Plan Rationale
This proposed business plan applies a proven state of the art computerized scheduling system to the
freight forwarding brokerage business. We plan to move freight worldwide by any type transportation--air,
sea, truck, rail--with the same accuracy, time sensitivity, and cost control that Federal Express now applies to
shipping small packages.
Inefficiencies in the Current Freight Forwarding Process
No multi-modal freight forwarder has achieved the efficiencies of an integrated system, like the one at
Federal Express, because existing manual systems for scheduling and tracking shipments are too clumsy.
Currently, a shipper has to use numerous transactions and transportation vendors to manage even one multimodal shipment through the tricky passageways of international shipping. No freight forwarder can predict
precisely when material will arrive or say with certainty where it is, and this lack of information drives up
inventory costs, transportation costs, and makes on-time delivery only a distant dream.
According to Joseph Barks writing in Distribution (May 1990), all the services needed to manage a
multi-modal shipment are now available. But "one-stop shopping" is not. No one company has yet developed
the communication system and the management expertise needed to offer a guaranteed quality service that
connects all pieces of the transportation pipeline--from shipper to consignee.
The Business Opportunity of "One-Stop" Freight Forwarding: DELSIS
Our business plan combines a sophisticated logistics management system and a
proven management team to create a "one-stop shopping" freight forwarding company.
The computerized data management and communications system, called "Demand Logistics
Scheduling and Information System" (DELSIS), was developed by Dr. T.G. Higgins over 15 years ago. This
system can coordinate, schedule, and record an infinite number of logistics activities on demand. As a result, it
provides immediate data control, instant information transfer, automatic billing and accounting, integrated
audit management, and data archiving. "The secret of business," according to Aristotle Onasis, "is to know
something that nobody else knows." DELSIS and the management team bring "what nobody else knows" to
the freight forwarding brokerage business.
Development of DELSIS
Dr. Higgins, with 40 years of logistics experience, holds the copyright for DELSIS through Planned
Systems, Design and Development (PSDD). The system currently operates successfully in the US Navy as
NALIS, in the US Army and US Air National Guard as CAASS, and will soon be adopted throughout the
federal government under the name "Demand Logistics Management System" (DLMS). Dr. Higgins also
authored a derivative of DELSIS, under the name ATAC, which the US Navy currently uses. DELSIS has
proven its ability to reduce dramatically the time and cost of moving any materials anywhere worldwide.
ATAC, for example, has demonstrated a savings of $7 million a day for the US Navy.
An Overview of the Business Plan
Our plan brings together already existing systems, resources, and expertise to create an integrated
freight forwarding business supported by the sophisticated logistics capabilities of DELSIS. The elements
comprising the plan include
The computerized logistics management system (DELSIS)
An experienced management team (led by Dr. Higgins)
An established freight forwarding business (the businesses to be purchased)
In addition to the proven logistics system, the business plan builds on the expertise of the management
team, their existing network of contacts in the industry, contracts already in place in the public sector
(Department of Defense and General Services Administration), and a successful logistics and inventory
management consulting business (PSDD).
We plan to expand DELSIS by purchasing an established freight forwarding businesses. The new
company will keep the name of the established forwarder and operate under its recognized name. The new
company will be divided into three business units:
Commercial: Domestic and International
Government Contracts: Aircraft Scheduling and Inventory Management
Logistics Services: Consulting and Outsourcing Services for Multinational Fortune 500
Companies
Combining the established resources and the acquired companies will create a company able to
deliver a new and unique freight forwarding service. Instant access to information through DELSIS will make
Quality Inventory Management at highly competitive prices a reality for customers. While other companies
offer logistics software, none combines the sophistication and proven functionality of DELSIS with the
management expertise to guarantee quality freight delivery.
We will offer the just in time inventory manager the same quality in transportation services he now
expects from manufacturing operations. For the first time ever, we will provide a global heavy weight shipper
the same guaranteed quality of service that Federal Express gives the small parcel shipper.
This business plan describes the implementation of the new commercial business unit. The other two
units, Government Contracts and Logistics Services, are already profitable established businesses (see
Appendixes A and B for descriptions of each). The plan includes the DELSIS System and the management
team, the market and competition, personnel, and the proposed use of funds.
Demand Logistics Scheduling and Information System (DELSIS)
What is DELSIS?
The DELSIS system is a state-of-the-art, computerized, multiuser scheduling system. It offers
demand scheduling solutions and provides numerous scheduling aids to ensure accurate and timely information
to manage distribution.
The Impact of DELSIS on the Freight Forwarding Business.
To envision the potential of the DELSIS system, imagine a pipeline for shipping. An item enters at
one end, and numerous individuals and companies have to move, locate, transfer, clear customs, etc., to
eventually maneuver the item to the other end of the pipeline. For example, to ship an automobile part from
Singapore to Tennessee different individuals have to get cost estimates, identify available transport, schedule
the route, actually move the part in and out of ports, and bill and audit the movement. With current manual
systems the only communication to connect these transactions is a fragmented system of phones, telexes, and
electronic mail. This means the shipper and receiver cannot know with any certainty where the part is in the
transportation pipeline. They face an opaque pipeline because no one can "see" in.
The Impact of Uncertainty. This uncertainty in the shipping process impacts transportation costs
and inventory management. Because of unpredictable delivery times, managers must keep extra inventory in
warehouses or in transit. Because of incomplete information on all possible transport schedules, or delays en
route, managers may have to warehouse inventory along the way. Because of manual audits and manual billing,
problems take extra time to correct and the resulting slow collections drive up financing costs. Because
shipping estimates and actual costs frequently do not match, shippers have added costs of hiring outside firms
to audit billing. All these unknowns raise costs through increased inventory and reduced planning efficiency.
The Impact of Information. Shipper and receiver could dramatically reduce costs and save time if
they had continuous access to information about the movement of items through the pipeline. Information on
schedules and reroutes could reduce uncertainty by providing a consignee with pre-alert information to
guarantee confidence in just in time delivery. If a business can always know where needed materials are and
predict arrival times, it can control inventory. Automated tracking and verifying of billing eliminates the need
to hire outside auditing firms and speeds up collections.
One way to view this ideal of just-in-time inventory is as "inventory in motion." Materials arrive just
as needed and are subject to minimal handling. Moving toward the ideal of Quality Inventory Management
(QIM) requires a transparent pipeline. That is, the shipper and receiver need to know what is going on inside
the transportation pipeline at all times in order to control the movement of goods quickly and accurately. The
DELSIS system provides that information. It offers modeling to develop the low cost transportation solution.
It allows the user instant access to shipping information 24 hours a day. It allows the user to track shipments,
to predict arrival times, to find the lowest cost and fastest service, to reroute quickly in case of emergency, to
achieve electronic proof of delivery and to do instant billing--and the user can do all this through his own
computer.
Features of the DELSIS System
The system makes available four extensive data bases (See Appendix C for a detailed list of
information available in the data bases):
Inventory Demand Data Base: Authorized users may access DELSIS via dialup
modems to request information on transportation, location, expected delivery time, and
Proof of Delivery of inventory.
Scheduled Carrier Data Base: The system plans the best route using information about
arrival times, space availability, operating hours, etc.
Carrier Availability Data Base: The system records information needed to find
immediately available air, sea, and land transport.
Carrier Performance Data Base: The system reports details on arrivals and deliveries.
Features of the computerized demand scheduling system include:
Sophisticated scheduling and distribution algorithms
Asset modeling applied to transportation options
Real-time collection and processing of logistics data
Open access to information through modems and PC's
Direct customer query of the database
Creation of detailed management reports
Performance exception reports and daily logs
System intelligence that constantly updates least cost algorithm
Electronic mail system to communicate among all users
Word processing with UNIX and AOS/VS operating systems
Single and multi-user models, using UNIX, MS-DOS, or AOS/VS operating
systems
Standardized Electronic Data Interchange (EDI) capabilities
Standard security features typical of a well-developed database management
system
Benefits of the DELSIS System
The features of the system allow users to immediately identify information about the movement of
inventory. This on-demand instant access to an expansive database has never before been available to multimodal shippers.
Real time on-line availability of information allows
proof of delivery and freight tracking
immediate answers to customer requests for inventory information
instant analysis of performance and cost alternatives of transportation carriers
constant monitoring the availability of transportation carriers
Access to the detailed information database allows
analytical summaries and modeling to determine optimum scheduling, etc. ("what if"
scenarios)
analysis of the impact of policies on shipping and inventory management
electronic consolidation of inventory for cost breaks
centralized management control of inventory movement through simultaneous scheduling,
tracking, and coordination of distribution
cost control and delivery timing through comparative information on transportation costs
relative to timing of deliveries
real-time audit to compare cost estimate to final bill
Flexible system design offers
capability to link to other computerized systems
adjustment to EDI standards for standardization of forms, procedures, etc.
full networking and telecommunications capabilities
"intelligent system" to improve distribution scheduling over time, based on
actual transportation performance
transportable between mini- and microcomputers
single and multi-user modes
Mr. Higgins was interviewed to gather additional information about this venture, and the following dialog
provides excerpts from this interview.
Case writer: How do you plan to start this venture?
Mr. Higgins: Well, first we plan to purchase an existing business to give us instant visibility and to provide us
with an initial set of equipment and personnel. I have been talking to several potential companies, and we
should have no problem finding a willing seller. In fact, I have developed a balance sheet of what the potential
acquisition candidate will look like.
Balance Sheet Data (000's)
Data at End of Start Month
Cash
Receivables
Other
Total Current Assets
Fixed Assets
Accumulated Depreciation
Net Plant Assets
Total Assets
$5
10,000
1
$10,006
$
3,500
0
3,500
13,506
Liabilities
Accounts Payable
Other Payables
Income Taxes Payable
Debt
Total Current Liabilities
$1,250
10,256
0
0
$11,506
Long Term Debt
Total Liabilities
0
$11,506
Common Stock
Retained Earnings
Total Equity
Total Liabilities & Equity
2,000
0
2,000
$13,506
Case Writer: You have shown us a balance sheet for the acquisition candidate, but what does the
income statement look like?
Mr. Higgins: Well, it would not tell you very much because we will completely restructure the
company after we buy it. Since you asked, though, the total annual sales for the past year were
$20,000,000; however, we expect to do at least $3,500,000 monthly for the first six months. After
that sales should rise about $50,000 per month for the next eighteen months. Because we will be
well established by then and many shippers will have heard about the superb service we provide, I
think sales will rise at least 20% for the next three years.
Case Writer: Once you have purchased the company, what do you plan to do next?
Mr. Higgins: First, we will start hiring people for our executive office in Pennsylvania, and then we
will begin hiring for the branches. We will have a lot of initial work to do in setting up the
software, so we should plan on about a six month period to get this done. It will probably cost us
about $300,000 for this process with the higher costs occurring in the first few months. We will
also spend about $1 million during the first four months just restructuring the company we
purchase. Communications costs will be a big issue with this business because we will be in
constant touch with brokers all over the world. It would not surprise me if we spend $15,000
monthly at the headquarters with another $2,000 for each branch location.
Case Writer: Branch locations? How many do you think you will have?
Mr. Higgins: Initially, we should have 17 branch locations with ten workers and a branch manager,
at least that is the number now operated by the company we hope to purchase when we get the
financing for this venture. We will probably stick with this number until the second year of
operations when we will expand at the rate of one per month. I think we can sustain this rate of
growth until we reach 30 branches, a number that should take care of all our needs.
Case Writer: What kind of costs will you incur in these branches?
Mr. Higgins: Every branch will have a manager who will earn $80,000 annually, and the other
personnel will each earn approximately $36,000 per year. All these amounts include fringes.
Rental cost should average $5,000 per month with an additional $1,000 for each automobile we use
at the branches. Branches will lease about six automobiles initially, and this will rise to eight by the
end of the second year, although we will probably not have to add any automobiles until we have
been in operation for ten months. Then there are the marketing supplies that should run about 4%
of revenues, utilities about .1% of revenues with an additional fixed component of about $800
monthly per station and $2,000 monthly for headquarters. In addition to a fixed amount,
communications costs will also average .1% of sales.
Case Writer: You have told us about the branches, but what about the costs at the headquarters?
Will there be similar costs there?
Mr. Higgins: Yes and no. Executives will cost about $3,000,000 annually, but the staff people
working there will earn about $30,000 annually because they will have lower skills than those
working in the branches. Also, the executives will do a lot of traveling--I estimate that each of the
twelve executives will spend about $3,000 monthly on travel because it is important for them to
constantly visit and maintain contacts with important customers and brokers throughout Europe and
Asia. Travel from Pennsylvania to Japan July 5, 1996 quickly adds up to a lot of money. Rent for
the headquarters building will cost us about $50,000 per month. We will also purchase equipment
for $2,100,000 in the first month that will be depreciated over seven years using the straight line
method.
Case Writer: Are there any other costs you can think of that we might have missed, costs for the
corporate office?
Mr. Higgins: Have I mentioned the DELSIS software? The corporate office will pay an annual fee
of $100,000 for using this software, and I estimate we will also incur about $45,000 annually in
insurance expenses.
Case Writer: You will be purchasing freight services from a variety of sources. What kind of terms
can you get from these providers?
Mr. Higgins: Most of the companies we will be working with are large, and they expect prompt
payment of all accounts. I expect we will have to pay all accounts in 30 days. Unfortunately our
customers will not be so diligent. We expect to collect accounts for the first six months in 45 days,
but after that we think that we can get it down to 33 days by the end of the second year of operation.
Getting below this level will be real difficult. Also, the $10,000,000 in receivables we acquire will
be collected slowly; we will probably still have $2,000,000 of this in month 1 and $1,000,000 in
month 2. This company has not been doing a great job of collecting their receivables.
Case Writer: You will be selling freight services for "list price," but buying them at wholesale.
What kind of discount from your selling price do you expect to get from the freight carriers?
Mr. Higgins: Initially we will pay about 70% of what we charge to the carriers. However, I expect
this to drop continuously as we develop volume and as we become better at bargaining with the
carriers. This percentage should drop about 7% per month, i.e., month 1 will cost us 70% of our
selling price although month 2 will be 3% lower than that, or .679% of sales. I see no reason why
we cannot maintain this rate of reduction throughout the first year. Then it will flatten out at
whatever we have at the end of the first year.
Case Writer: What kind of financing terms have you been able to arrange with financial institutions?
Mr. Higgins: My banker says I should be able to borrow money at prime plus two percentage
points. Of course, she will not finance the whole venture for me, but we should be able to get a
reasonable line of credit at these terms. If we can get an investor to put up $5 million, I think we
are ready to roll.
Required: Prepare monthly financial statements for two years, and prepare annual financial
statements for the full five years. Use a tax rate of 35% for your income tax calculations. Also,
assume income taxes are paid quarterly and assume every third month is the end of a quarter, i.e., in
month 3 the company pays all income taxes for the first three months; in month 6 it pays all income
taxes for the second three months, etc.