Solution to Toy World, Inc.
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, and prudence would suggest more. The 1.5 percent commitment fee would mean a cost of $1,500 per year per $100,000 of unused line. This $1,500 can be thought of as an insurance premium against the chance that the forecast will not be realized. If the forecast is thought to be quite accurate, then it would probably not be worth it to get a line over about $600,000. However, the toy business is unpredictable, hence a safety margin would probably be a good idea. That would suggest a larger line, say $750,000.
Of course, if the company can negotiate and get the $450,000 compensating balance reduced, this would reduce the cash required and thus the credit line requirements. Also, if the commitment fee were raised or lowered, that too would affect the decision.
In summary, based on the information at hand, we would recommend that the company seek a credit line in the range of $600,000 to $800,000, and also that it seek more flexibility in its compensating balance requirement.
11. Dan Culbreth has been thinking about possibly changing production procedures so as to level out production during the year. This would stabilize the labor force and probably lower per unit costs. Can you think of any possible negative effects of such a change, and would a production process change affect cash requirements?
The company would have to start production early in the year to build up product for the peak sales. This early production would have to be financed, costs would be incurred early, sales and collections would follow much later. If the funds were to be borrowed, the credit line would be much larger than what we have discussed thus far. Another drawback to leveling out production is that toy sales are somewhat unpredictable, so it is better to wait for orders before producing. It would be a big mistake to produce a lot of a particular type of toy back in the spring and then have...
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