1. What factors should Mr.

McClintock consider in deciding whether or not to adopt the level

production plan?

The main factor that Mr. McClintock should consider is the tradeoff between liquidity and profitability.

The plastic toys industry that the company operates is highly seasonal as mentioned in the case. Given

that it is hard to predict nature of the business, there is a risk associated with stocking the inventory

as the industry has short product lives and the competitors can replicate the products in a short

amount of time. As a result, there is a high risk of inventory obsolescence. If managements projections

are incorrect, the company could incur significant inventory write-down and write offs.

In addition, the company will incur extra costs of storing the inventory which accumulates during the

first half of the year. As the firm depends on external funding for the production, early borrowing of

the fund for the adoption of level production plan can make the interest payable accumulate and

increase the financial constraint of the firm. Mr. McClintock should also consider whether the credit

line of $2m can support the level production and whether an increase of the credit line is possible in

case it is needed to perform that strategy.

Last but not least, if the Mr. McClintock wants to adopt the level production plan, he should rethink

the firms cash management process. At the moment, most customers take 60 days to pay the account

receivable to Toys World although the firm imposes a term of net 30 days. In contrast, the firm is

having purchases with net 30-days term for their production. As a result, the firm is operating with a

negative cash cycles which impacted severely on their cash position. If the firm adjusts their production

schedule, the situation of their cash cycle may become worse which may impact their financial

coverage.
2. Summarize the cost differential between the options that would be used to forecast the external

funding requirements?

The cost elements which would be impacted by the production decision will be:

Overtime wage premium

If the level production is implemented, there is no need for the factory workers to work overtime

during the peak sales season. Therefore, there will be saving of overtime wage which is estimated at

$225,000.

Addition direct labor savings

If the level production is implemented, there will be stability in the workforce throughout the year

which will reduce turnover rate as well as training cost for new employees. The estimated saving

from the stability of workforce will be $265,000.

Higher storage and handlining cost

In contrast, an increase in the inventory will increase the inventory storage and handling cost which

is estimated at $115,000

Total cost differentials will be = $225,000 + $265,000 - $115,000 = $375,000 in saving before tax

After tax cost saving will be $375,000 x ( 1 0.34) = $247,500

Impact of higher interest expense

As mentioned in the first question, the level production will increase company interest expense as

the firm has to use the credit for early production during the year with very low sales to repay the

credit. As a result, the firm will incur more interest expense during the year. The impact of higher

interest expense has not been quantified.