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Polar Sports Inc Case Solution
If the bank is not willing to extend the present line of credit, Polar sports can attract investments from other sources. It can opt for equity financing to raise capital. This is a comparatively cheap and a safer mode of funding as the equity holders cannot force a business to pay them dividends if it is loss making, unlike debt holders who can force Polar sports into bankruptcy in case of failure to meet the legal obligations (Cassar, 2004).
Following questions are answered in this case study solution
Which factors should Mr. Weir consider in deciding whether to adopt level production?
What are the total savings from adopting level production?
Evaluate the trade-off between profitability and liquidity in adopting seasonal or level productions
Think about the concerns of Polar’s bank. As the banker, would you be willing to extend the line of credit to more than $4 million to finance level production? Why or why not?
What other sources could substitute in part for bank lending if the lender is not willing to extend the present line of credit?
Compare the liability patterns feasible under the alternative production plans. What implications do their differences have for the risk assumed by the various parties?
What would be the impact of unsold inventory on cash flows and projected cost savings?
Case Analysis for Polar Sports Inc
1. Which factors should Mr. Weir consider in deciding whether to adopt level production?
Firstly, Mr Weir needs to prepare financial feasibility and consider before going ahead with the plan of undertaking level production. He should, therefore, ensure that the line of credit does not exceed the 2/3rd of total account receivables and inventory to eliminate any possibility of violation of the existing loan covenant. Secondly, he should assess the demand for the current designs of the business to be sure that it will be able to sell all of its inventory in the peak season. Thirdly, by doing a cost-benefit analysis, Mr Weir will have to consider associated costs about the handling and related benefits from less maintenance to determine whether it is an appropriate approach or not. Furthermore, the impact on the cost of production also needs to be assessed to make an informed decision which would contribute towards reducing costs and making Polar Sports competitive (Boone, 2008).
2. What are the total savings from adopting level production?
The total cost savings from adopting level production would be in the form of reduced overtime premium and maintenance costs which would be worth $480,000. This is because workers won’t have strong pressure on them to produce high volumes in short deadlines as production will be evenly spread. This will also improve worker motivation and increase productivity levels (Stuebs & Sun, 2010). Furthermore, maintenance costs will be reduced as the machinery will not be sitting idle. Apart from this, reduced hiring in peak months will further reduce costs in case of level production as the number of workers will stay the same throughout all the months. From this activity, it is expected to save an additional $600,000. However, these will be partially offset by the inventory handling costs as the sales of the products are seasonal. This increase is expected to be equal to $300,000. Thus, the total cost savings from choosing level production will be approximately $780,000.
3. Evaluate the trade-off between profitability and liquidity in adopting seasonal or level productions
By adopting seasonal production, there is improved profitability as only the demanded designs will be produced. This makes business very responsive to changing customer tastes. However, maintaining high liquidity is a concern as all the production gets focused in specific months from September to January which places massive pressure on cash management.
In the case of level production, the production would evenly accrue over the months. However, for the ski wear manufacturing industry, the competitors are continually coming up with new designs to attract the customers. This can lead to tremendous amount of inventory piling up or being obsolete as projecting the designs that will be sold is difficult Apart from this, it can increase account receivables and place the business in a problematic position as it would then be violating the loan covenant. Furthermore, by spending much cash on the inventory which would not be selling at a quicker speed, its liquidity position will also deteriorate (Eljelly, 2004).
4. Think about the concerns of Polar’s bank. As the banker, would you be willing to extend the line of credit to more than $4 million to finance level production? Why or why not?
Polar Sports financial position looks satisfactory as its financial statements show a steady growth rate with consistent profitability. Thus, it can be assured that the business will be going concern. The proforma statements do not indicate that the firm will break the covenants since the loan amount has not exceeded the 2/3rd of the accounts receivables and the inventory in any of the month. Through level production, Polar sports will see its inventory grow at a consistent rate monthly which will show that the business is liquid to some extent. The stock turnover ratio and the current ratio show a more uniform trend in level production as they rise and then fall later unlike seasonal production which shows considerable fluctuations in the pro forma trends. The current annual ratio is substantially high for seasonal production which is approximately 10.4 and stock turnover being 7.9 which shows that the liquidity is very high which could be used in some other investment to generate returns (Tran, Abbott, & Jin Yap, 2017).
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