Cash flow analysis, sensitivity analysis. Game Depot is a ...

[Sufayan.ah]

Cash flow analysis, sensitivity analysis.
 
  Game Depot is a retail store selling video games. Sales are uniform for most of the year but pick up in June and December both because new releases come out and because consumers purchase games in anticipation of summer or winter holidays. Game Depot also sells and repairs game systems. The forecast of sales and service revenue for the MarchJune 2014 is as follows:
 
  Almost all the service revenue is paid for by bank credit card, so Game Depot budgets this as 100 bank card revenue. The bank cards charge an average fee of 3 of the total. Half of the sales revenue is also paid for by bank credit card, for which the fee is also 3 on average. About 10 of the sales are paid in cash, and the rest (the remaining 40) are carried on a store account. Although the store tries to give store credit only to the best customers, it still averages about 2 for uncollectible accounts; 90 of store accounts are paid in the month following the purchase, and 8 are paid 2 months after purchase.
 
  Required:
  1. Calculate the cash that Game Depot expects to collect in May and in June 2014. Show calculations for each month.
  2. Game Depot has budgeted expenditures for May of 8,700 for the purchase of games and game systems, 2,800 for rent and utilities and other costs, and 2,000 in wages for the two part-time employees.
  a. Given your answer to requirement 1, will Game Depot be able to cover its payments for May?
  b. The projections for May are a budget. Assume (independently for each situation) that May revenues might also be 5 less and 10 less and that costs might be 8 higher. Under each of those three scenarios, show the total net cash for May and the amount Game Depot would have to borrow if cash receipts are less than cash payments. Assume the beginning cash balance for May is 200.
  3. Why do Game Depot's managers prepare a cash budget in addition to the revenue, expenses, and operating income budget? Has preparing the cash budget been helpful? Explain briefly.
  4. Suppose the costs for May are as described in requirement 2, but the expected cash receipts for May are 12,400 and beginning cash balance is 200. Game Depot has the opportunity to purchase the games and game systems on account in May, but the supplier offers the company credit terms of 2/10 net 30, which means if Game Depot pays within 10 days (in May) it will get a 2 discount on the price of the merchandise. Game Depot can borrow money at a rate of 24. Should Game Depot take the purchase discount?

Question 2

Red Baron Company purchased supplies for cash, 1,950 . The transaction would involve a
 a. debit to Cash.
   b. credit to Accounts Payable.
   c. credit to Supplies Expense.
   d. debit to Supplies.

[IAPPLET]

Answer to Question 1

1. The cash that Game Depot can expect to collect during May and June is calculated below.

Cash collected in May June
From service revenue
May (2,800  0.97)  2,716
June (5,200  0.97)  5,044
From sales revenue
Cash sales
From credit card sales
May (0.5  12,400  0.97) 6,014
June (0.5  19,400  0.97) 9,409
From cash sales
May (0.1  12,400) 1,240
June (0.1  19,400) 1,940
Credit sale collections
From March (0.4  9,000  0.08) 288
From April (0.4  11,000  0.9) 3,960
(0.4  11,000  0.08) 352
From May (0.4  12,400  0.9) _______ 4,464
Total collections 14,218 21,209

2. (a) Budgeted expenditures for May are as follows.
Costs
Inventory purchases  8,700
Rent, utilities, etc. 2,800
Wages 2,000
Total 13,500

Yes, Game Depot will be able to cover its May costs because receipts are 14,218 and expenditures are only 13,500.

(b)

Original
numbers May Revenues
decrease 10

May Revenues
decrease 5

May Costs
increase 8

Beginning cash  200.00  200.00  200.00  200.00
Collections 14,218.00 13,221.00a 13, 719.50b 14,218.00c
Cash Costs 13,500.00 13,500.00 13,500.00 14,580.00
Total  918.00  (79.00)  419.50  (162.00)

aFrom requirement 1, this is 0.90  (2,716 + 6,014 + 1,240) + 288 + 3,960 = 13,221
bFrom requirement 1, this is 0.95  (2,716 + 6,014 + 1,240) + 288 + 3,960 = 13,719.50
c13,500  1.08 = 14,580.

3. Game Depot's managers prepare a cash budget in addition to the operating income budget to plan cash flows to ensure that the company has adequate cash to pay vendors, meet payroll, and pay operating expenses as these payments come due. Game Depot could be very profitable on an accrual accounting basis, but the pattern of cash receipts from revenues might be delayed and result in insufficient cash being available to make scheduled payments for its expenses. Game Depot's managers may then need to initiate a plan to borrow money to finance any shortfall. Building a profitable operating plan does not guarantee that adequate cash will be available, so Game Depot's managers need to prepare a cash budget in addition to an operating income budget.

4. The cost of inventory purchases without the discount is 8,700, which Game Depot would not have to pay until June if it buys the inventory on account in May. However, if it takes the discount and pays in May, the cost will be 8,700  (100  2) = 8,526. This means it will save 174.

This makes total expenditures for May
Costs
Inventory purchases  8,526.00
Rent, utilities, etc. 2,800.00
Wages 2,000.00
Total 13,326.00

Game Depot's total cash available is 200 (cash balance) + 12,400 (cash receipts), so it will have to borrow 726 (13,326  12,600) at a rate of 24 percent (or 2 percent per month.) Based on the information from 1, it will be able to pay this back in June (assuming cash expenditures do not increase dramatically), so it will incur interest costs of 726  0.02 = 14.52. Because it will cost them less than 15 to save 174, it makes sense to go ahead and take the short-term loan to pay the account payable early.

Some students might interpret the question to mean that the cost of inventory purchases after taking the 2percent discount in May is 8,700. Under this interpretation, the cost of the inventory is 8,700  0.98 = 8,878. If Game Depot takes the discount and pays in May, it will save 8,878  8,700 = 178

Total expenditures in May:
Inventory purchases 8,700
Rent, utilities, etc. 2,800
Wages 2,000
Total 13,500

Total cash available is 200 + 12,400 = 12,600, so Game Depot will borrow 900 (13,500  12,600) at a rate of 24 percent (or 2 percent per month). The company can repay in June, so interest cost = 900  0.02 = 18. It will cost 18 to save 178, so Game Depot should take the short-term loan to pay the accounts payable early.

Answer to Question 2

d