Reference no: EM132460074

Jadyn Industries (JI) is a small company that fabricates composite materials for industrial applications. Headquarters are in a remote section of the Wisconsin. A supplier in New Jersey ships raw material (mostly rolled composite sheeting) to JI.

One problem facing Darnell Robinson, JI's president is cash forecasting. Mr. Robinson arranges materials shipments from the New Jersey supplier many months in advance. These purchases are a large portion of the JI's cash outflows. He cannot easily adjust purchases (and thus cash outflows) downward in response to lower sales and hence, lower cash inflows. In addition, Mr. Robinson does not lay off workers in the event of a temporary decline in demand.

Since Mr. Robinson cannot quickly cut payrolls and material purchases in response to unexpectedly lower sales, he could face cash shortages. At the beginning of each month, he generates cash forecasts for the following twelve months, identifying months he expects surpluses and deficits. Mr. Robinson finances temporary deficits by borrowing from a line of credit.

In late December of 2019, Mr. Robinson is making a cash forecast for the upcoming 12 months. He knows schedules of materials purchases and estimates expenses over the planning period. These are in Table 1. JI's collection forecast is 4% from the current month's sales, 66% from the first month prior sales, and 30% from the second month prior sales.

The beginning cash balance for the forecasting period (that is, the firm's actual cash balance at the end of December 2019) is $84,000. JI maintains a desired cash balance, along with a line of credit as reserves against running out of cash. Mr. Robinson desires a monthly ending cash balance of 5% of a given month's sales. Ending cash balances vary. Estimates of the standard deviations of the monthly cash surpluses or deficits are in Table 2. JI's credit line allows for a maximum principal outstanding of $50,000 (the full amount is currently available). Commitment fees, interest rate and compensating balance information for the line of credit are in Table 3. Mr. Robinson's lender will credit JI 10% of its average ending cash balance toward the required compensating balances. If JI had an average ending cash balance of $100, the lender would reduce required compensating balances by 10% X $100 = $10.

1. Generate the cash forecast for JI on a monthly basis for the period of January 2020 through December 2020. Ignore investment income from surplus cash and interest expense on funds borrowed from the line of credit.   

2. Based on the surpluses or deficits that you estimated for the next 12 months, calculate the probability that JI will run out of cash in each month of the forecast period. Assume monthly ending surpluses and deficits are normally distributed.

3. How large of a credit line would JI need in order to have a 3% probability of running out of cash?

4. Mr. Robinson expects to borrow in order to meet the deficits you estimated in question 1 above. Calculate the effective interest rate on the line of credit. For the size of the line of credit, use the amount you calculated for question 3 above (not the amount from the CRLN equation). Include the idle balance credit that the lender allows.

5. Any amount available from the line of credit above the minimum size required to meet the largest deficit you estimated in question 1 is essentially a buffer against larger than expected deficits. Estimate the cost ($) of the buffer based on the size of the line of credit you estimated in question 3.