HA.T.

N Page 1

CHEMALITE, INC. (B)

1. Prepare a proforma statement of cash flows for 1992 using the indirect
method.

Balance Sheet as at December 31, 1991 and
1992
Dec 31,
1991
(actual)
Dec 31,
1992
(pro-
forma)
Change in
Account
Balance
Assets
Cash $113,000 $9,490 ($103,510)
Accounts receivable 69,500 139,530 70,030
Inventories raw material 55,000 75,450 20,450
Inventories-finished goods ----------- 104,680 104,680
Prepaid insurance ----------- 65,000 65000
Property, plant and equipment 212,500 1,120,000 100500
Accumulated depreciation (10,625) (56,000) (45,375)
Land ----------- 250,000 250,000
Patent 100,000 75,000 (25,000)
Total assets $539,375 $1,783,150
Liabilities and owners Equity
Short-term debt ----------- 200,000 ($200,000)
Taxable payable 10,900 9,950 950
Deferred income taxes ----------- 26,730 (26,730)
Notes payable (10%) ----------- 425,000 (425,000)
Long-term debt (10%) ---------- 510,000 (510,000)
Dividends payable 10,000 12,000 (2,000)
Common Stock 500,000 500,000 0
Retain earnings 18,475 125,470 (106,995)
Treasury Stock ----------- (26,000) 26,000
Total liabilities and owners
equity
$539,375 $1,783,150 0



HA.T.N Page 2









CHEMALITE INCORPORATION
Statement of Cash Flows - Indirect Method
For the Year Ended December 31, 1992
Cash flows from operating activities
Net income $118,995
Adjustment to reconcile net income to net cash
provided by operating activities

Depreciation and Amortization


$86,625
a


Provided for deferred Income tax 26,730
Gain on sale of equipment (24,250)
Net change in
Account receivable (70,030)
Inventory

(120,130)
b


Prepaid expense (65,000)
Taxes payable (950)
Net cash provided by operating activities ($48,010)
Cash flows from investing activities
Capital expenditure for P&E

(945,000)
c


Proceed from sale of Equipment 215,500
Net cash used in investing activities ($729,500)
Cash flows from financing activities
Proceed from issuance of Long-term debt 510,000
Proceed from issuance of Short-term debt 200,000
Dividends paid


(10,000)
d


Purchase of treasury story (26,000)
Net cash provided by financing activities $674,000
Net decrease in cash

(103,510)
Cash at beginning of the year 113,000
Cash at the end of the year $9,490

HA.T.N Page 3

Indirect method computation:
(a) Computation of Depreciation and Amortization

Depreciation of new building =
10
2 : ) 000 , 250 000 , 850 (
= $30,000 (point 4 in the case)
Depreciation of new equipment =
10
2 : 000 , 520
= $26,000 (point 5 in the case)
Depreciation of used machines purchased in June = $10,625 (point 6 in the case)
Depreciation Expense ( and Inventories-finished goods) = $30,000 + $26,000
+ $10,625 = $66,625




(b) Inventories
Increase in Inventories-raw material $ 20,450
Add: Inventories-finished goods 104,680
Deduct: depreciation of Finished good inventory 5,000

Net change in Inventories $ 120,130

(c) Capital expenditure for P&E
Purchase of Equipment $520,000
Add: Purchase of land and a building 850,000
Deduct: notes payable (425,000)
Capital expenditure for P&E $945,000


(a) Dividends paid

Net income $ 118,995
Deduct: increase in retained earning 106,995
Deduct: Increase in Dividends payable 2,000

Dividends paid $ 10,000



Depreciation Expense (and inventories-finished goods) $66,625
Deduct: Depreciation of Inventories-finished goods 5,000
Add: Amortization of patent 25,000
Depreciation and Amortization $ 86,625
HA.T.N Page 4

2. Prepare a proforma statement of cash flows for 1992 using the direct
method.


CHEMALITE INCORPORATION
Statement of Cash Flows - Direct Method
For the Year Ended December 31, 1992

Cash flows from operating activities
Cash collections from customers $1,816,220
(a)

Cash paid to supplier
Material $473,150
(b)

Labor 660,000
Finished goods inventory 99,680
(c)

Rent 25,000
Utilities 82,000
Advertising 70,000
R&D 63,250
Insurance 97,500
(d)

S&A expense 195,750
Interest expense 58,570
Income tax 39,150
(e)

Net cash provided by operating activities (48,010)
Cash flows from investing activities
Capital expenditure for P&E (945,000)
(f)

Sale of equipment 215,500
Net cash used by investing activities (729,500)
Cash flows from financing activities
Proceed from insurance of long term debt 510,000
Proceed from insurance of short term debt 200,000
Dividend paid 10,000
Purchase of treasury stock 26,000
Net cash provided by financing activities 674,000
Net decrease in cash (103,510)
Cash at beginning of the year 113,000
Cash at the end of the year $ 9,490







HA.T.N Page 5

Direct method computation:
(a) Computation of cash collections from customers

Computation of cash paid for suppliers
(b) Material
Material $452,700
Add: average stock of raw material (point 3 in
the case)
75,450
Deduct: inventories raw material in 1991 55,000
Material $476,150

(c) Finished goods inventories
Finished goods inventories $104,680
Deduct: Depreciation of finished goods
inventories
5,000
Finished goods inventories $ 99,680

(d) The cost of the insurance for the building, inventories and business disruption is $
97500 cash (point 7 in the case)
=> Insurance = $97500
(e) Income tax
Income taxes in Dec, 31, 1992 $64,930
Add: Decrease in taxes payable 950
Deduct: deferred income taxes (26,730)
Income taxes
$39,150

(f) Capital expenditure for P&E
Purchase of Equipment $520,000
Purchase of land and a building 850,000
Deduct: notes payable (425,000)
Capital expenditure for P&E $945,000

Revenue per the income statement

$1,886,250
Deduct: Increase in Account receivable

(70,030)
Cash collections from customers

$1,816,220
HA.T.N Page 6

3. What are the main sources and uses of cash revealed by your analysis?



Sources of cash

Cash Received from Customers $1,816,220
Proceed from sale of equipment $ 215,500
Long-term Debt $ 510,000
Short-term Debt $ 200,000
Total Sources $2,741,720
Uses of cash
Cash Payments (Purchases and operating
expenses)

Material $ 473,150
Labor $ 660,000
Finished goods inventories $ 99,680
Rent $ 25,000
Utilities $ 82,000
Advertising $ 70,000
R&D $ 63,250
Insurance $ 97,500
S&A expense $ 195,750
Interest $ 58,750
Income tax $ 39,150
Capital expenditure for P&E $ 945,000
Stock buyback $ 26,000
Dividends paid $ 10,000
Total Uses $2,845,230
Net subtraction to cash

$ 103,510
















HA.T.N Page 7

4. What would you recommend to Bennett Alexander?
Look at the statement of cash flow above, we see that the debt level of Chemalite,
Inc. is pretty high. After calculating the equity/ total liabilities and equity at the end of
1992, we have:
Total Equity/ Total liabilities and equity ratio = (Common Stock + Retain Earnings +
Treasury Stock)/ Total liabilities and equity
= ($500,000 + $125,740 - $26,000)/ $1,783,150 = $599,470 / $1,783,150
= 33.6%
In addition, its cash position which is $9,490 is not attractive.
ROE = Net Income / Total Equity = 24.3%
This simple ratio tells us that Chemalite, Inc. is doing very well economically.
Undoubtedly, the company is planning to go through a very heavy investment plan
during 1992 and this is reflected in the $729,500 cash used in investment activities.
Due to its growth, Chemalite, Inc. is not generating cash from its operating activities.
We think that Bennet Alexander should make alternatives in strategy, operation,
and finance.
First of all, Bennet Alexander should change companys strategy. Currently, the
company is performing strategy that has a volume-based focus, building market
share to push up its market power as well as decline the attractiveness of the
industry to potential entrants. This alternative strategy is to increase prices and
become the top-quality supplier in the chemalite industry. This method could
require less investment and less cash to sustain working capital. And, the other
strategic method is to change the expansion plans and make them more
progressive given the availability of funds. This way means a lower expansion
which is translated in lost demand and easier entry of competitors.
Secondly, the degrees of freedom here are much reduced. Bennet can require timely
payments by wholesalers, 30 days rather than 40 days; this will provide company
with cash worth:
$139,530 / 40 days * 10 days = $34,882
He can also negotiate with raw materials suppliers to get 30 days credit for the
purchase of raw materials. This action will provide Chemalite, Inc. with cash worth:
$473,150 / 365 days * 30 days = $38,889
Furthermore, there is the alternative of subcontracting production or factoring
Accounts Receivable.
HA.T.N Page 8

Finally, Bennet should consider financial activities, here again the options are very
narrow. The debt structure of Chemalite, Inc. does not seem to provide a lot of room
to increase the debt levels. The only option is to work with equity. Therefore,
stopping dividend payments and issuing new stock are two possible methods
given out.
In any case, Bennet Alexander should carefully prepare the March meeting: present
the liquidity problem that the investments and growth will cause and the various
alternatives open to solve this crisis. He should also look at the shorter time
periods, rather than being satisfied with the year outlook to analyze when the
liquidity problem is going to begin to be acute and when new financing is going to be
required.