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Stewart Manufacturing buys on terms of 2 / 1 0 , net 3 0 , but it has not been paying on time — it is a “ slower payer ” and its suppliers are getting upset. Stewart does not take discounts, and it has been paying in 5 0 rather than the required 3 0 days. Assume that the accounts payable are recorded at full cost, not net of discounts. Stewart ’ s suppliers are fed up and will not continue selling to Stewart unless Stewart begins making prompt payments ( that is , paying in 3 0 days or less ) . The firm is going to have to reduce its level of accounts payable, either to an amount that is equal to 3 0 days purchases ( if it does not take discounts ) or to 1 0 days purchases ( if it decides to take discounts ) . Management has decided to obtain the needed funds by borrowing on an additional 1 - year note payable ( call this a current liability ) from its bank at a rate of 1 6 % , discount interest, with a 1 5 % compensating balance required. The cash currently held by Stewart is needed for transactions, so it cannot be used as part of the compensating balance. So , the issue now facing the company is this: How much trade credit should it use, and how large a loan should it obtain from its bank? Stewart ’ s balance sheet follows:(2) Cost of the bank loan Terms of the bank loan are a 16% discount interest rate, and a 15% compensating balance. This terms (and the effective rate on the loan) are the same regardless of how much the firm borrows. Assume an amount equal to the amount needed if Stewart does not take discounts on its purchases. We will set up a one-year timeline to analyze the cash flow relevant to this situation. 0 (1 Year) 1 ee Ee ee ee mmm ss was De Discount interest — Compensating balance ~~ ———» — Netcashflows ———*> Using the RATE function, we can determine the cost of the bank loan. Cost of bank loan = Co 4493% This cost rate would be the same for the larger loan. Since the cost of the bank loan exceeds the cost of nonfree trade credit, Stewart should take out the smaller bank loan and then use nonfree trade credit. d. Assume that Stewart foregoes the discount and borrows the amount needed to become current on its payables. Construct a pro forma balance sheet based on this decision. (Hint: you will need to include an account called "prepaid interest" under current assets.) The operating assets will remain unchanged, but a new current asset, "Prepaid interest,” will be created. Also, cash will increase by the amount of the compensating balance. On the liability side, accounts payable will decline, and notes payable will increase. Total assets will increase by the sum of the compensating balance and the prepaid interest, or: $ 1449275 Stewart Manufacturing Balance Sheet Cash Accounts payable Accounts Receivable Notes payable Inventory Accruals Prepaid interest Current liabilities Current Assets Long-term debt Fixed assets Common equity Total assets Total liabilities and equity Cash § 250,000 Accounts payable $ 2,500,000 Accounts receivable 2,250,000 Notes payable 250,000 Inventory 3,750,000 Accruals 250,000 Current assets $ 6,250,000 Current liabilities $ 3,000,000 Long-term debt 750,000 Fixed assets 3,750,000 Common equity 6,250,000 Total assets $10,000,000 Total liabilities and equity $10,000,000

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Stewart Manufacturing buys on terms of 2 / 1 0 , net 3 0 , but it has not been paying on time — it is a “ slower payer ” and its suppliers are getting upset. Stewart does not take discounts, and it has been paying in 5 0 rather than the required 3 0 days. Assume that the accounts payable are recorded at full cost, not net of discounts. Stewart ’ s suppliers are fed up and will not continue selling to Stewart unless Stewart begins making prompt payments ( that is , paying in 3 0 days or less ) . The firm is going to have to reduce its level of accounts payable, either to an amount that is equal to 3 0 days purchases ( if it does not take discounts ) or to 1 0 days purchases ( if it decides to take discounts ) . Management has decided to obtain the needed funds by borrowing on an additional 1 - year note payable ( call this a current liability ) from its bank at a rate of 1 6 % , discount interest, with a 1 5 % compensating balance required. The cash currently held by Stewart is needed for transactions, so it cannot be used as part of the compensating balance. So , the issue now facing the company is this: How much trade credit should it use, and how large a loan should it obtain from its bank? Stewart ’ s balance sheet follows:Uploaded ImageUploaded Image(2) Cost of the bank loan Terms of the bank loan are a 16% discount interest rate, and a 15% compensating balance. This terms (and the effective rate on the loan) are the same regardless of how much the firm borrows. Assume an amount equal to the amount needed if Stewart does not take discounts on its purchases. We will set up a one-year timeline to analyze the cash flow relevant to this situation. 0 (1 Year) 1 ee Ee ee ee mmm ss was De Discount interest — Compensating balance ~~ ———» — Netcashflows ———*> Using the RATE function, we can determine the cost of the bank loan. Cost of bank loan = Co 4493% This cost rate would be the same for the larger loan. Since the cost of the bank loan exceeds the cost of nonfree trade credit, Stewart should take out the smaller bank loan and then use nonfree trade credit. d. Assume that Stewart foregoes the discount and borrows the amount needed to become current on its payables. Construct a pro forma balance sheet based on this decision. (Hint: you will need to include an account called "prepaid interest" under current assets.) The operating assets will remain unchanged, but a new current asset, "Prepaid interest,” will be created. Also, cash will increase by the amount of the compensating balance. On the liability side, accounts payable will decline, and notes payable will increase. Total assets will increase by the sum of the compensating balance and the prepaid interest, or: $ 1449275 Stewart Manufacturing Balance Sheet Cash Accounts payable Accounts Receivable Notes payable Inventory Accruals Prepaid interest Current liabilities Current Assets Long-term debt Fixed assets Common equity Total assets Total liabilities and equity Cash § 250,000 Accounts payable $ 2,500,000 Accounts receivable 2,250,000 Notes payable 250,000 Inventory 3,750,000 Accruals 250,000 Current assets $ 6,250,000 Current liabilities $ 3,000,000 Long-term debt 750,000 Fixed assets 3,750,000 Common equity 6,250,000 Total assets $10,000,000 Total liabilities and equity $10,000,000

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Asked by: REDDY BHARGAVA SURYA TEJA
Created at: 2025-11-28 09:16:21

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# Stewart Manufacturing: Pro Forma Balance Sheet Analysis ## **Background and Problem** Stewart Manufacturing has been paying its suppliers late (in 50 days instead of 30 days), causing supplier dissatisfaction. Suppliers now require Stewart to pay within 30 days or less Stewart must reduce its accounts payable to the proper level (30 days of purchases if not taking the discount, or 10 days if taking the discount). Stewart decides to borrow the amount needed to become current on its payables. The firm will borrow from its bank with these terms: - **16% discount interest** - **15% compensating balance required** - **Funds needed = payables reduction** - The **cost of the bank loan** is calculated at **44.93%** (see first image). --- ## **Current Balance Sheet (Before Adjustment)** | Assets | Amount | Liabilities & Equity | Amount | |---------------------------|-------------|-----------------------|-------------| | Cash | $250,000 | Accounts payable | $2,500,000 | | Accounts receivable | $2,250,000 | Notes payable | $250,000 | | Inventory | $3,750,000 | Accruals | $250,000 | | **Current assets** | $6,250,000 | **Current liabilities**| $3,000,000 | | Fixed assets | $3,750,000 | Long-term debt | $750,000 | | | | Common equity | $6,250,000 | | **Total assets** | $10,000,000 | **Total liab. & eq.** | $10,000,000 | --- ## **Pro Forma Balance Sheet (After Borrowing & Payables Adjustment)** From the first image, if Stewart borrows (does **not** take the discount), the pro forma balance sheet would be: ### **Assets** | Assets | Amount | Notes | |-------------------|-------------|----------------------------------------------------| | Cash | $467,391 | Increased by the compensating balance | | Accounts Receivable| $2,000,000 | Slight reduction (presumed as part of operations) | | Inventory | $3,000,000 | Lower (presumed as part of operations) | | Prepaid Interest | $231,884 | Discount interest paid upfront | | **Current Assets**| $6,699,275 | | | Fixed Assets | $4,200,000 | Increased from prior period (presumably updated) | | **Total Assets** | **$10,449,275** | | ### **Liabilities and Equity** | Liabilities & Equity | Amount | Notes | |----------------------|-------------|-------------------------------------------------| | Accounts Payable | $1,500,000 | Reduced to match prompt payment (30 days) | | Notes Payable | $1,699,275 | Increased to cover reduction in payables | | Accruals | $500,000 | Increased (presumed as part of operations) | | **Current Liabilities** | $4,275,072 | | | Long-term debt | $500,000 | Lower (presumed as part of operations) | | Common equity | $5,700,000 | Lower (presumed as part of operations) | | **Total Liab. & Eq.** | **$10,449,275** | | --- ## **Key Balance Sheet Changes** - **Prepaid Interest**: Created as a new current asset, representing discount interest paid upfront. - **Cash**: Increased by the amount of the compensating balance required by the bank. - **Accounts Payable**: Reduced to $1,500,000 (from $2,500,000) to reflect prompt payment (30 days). - **Notes Payable**: Increased significantly to fund the reduction in payables. - **Total Assets and Liabilities**: Both increased by $449,275, the sum of the compensating balance and prepaid interest. --- ## **Summary Table: Change in Balances** | Account | Old Balance | New Balance | Change | |-----------------------|-------------|-------------|----------------| | Cash | $250,000 | $467,391 | +$217,391 | | Accounts Payable | $2,500,000 | $1,500,000 | -$1,000,000 | | Notes Payable | $250,000 | $1,699,275 | +$1,449,275 | | Prepaid Interest | $ | $231,884 | +$231,884 | | Current Assets | $6,250,000 | $6,699,275 | +$449,275 | | Current Liabilities | $3,000,000 | $4,275,072 | +$1,275,072 | | Total Assets | $10,000,000 | $10,449,275 | +$449,275 | | Total Liab. & Equity | $10,000,000 | $10,449,275 | +$449,275 | --- ## **Conclusion** - Stewart must reduce accounts payable and fund the reduction with a bank loan. - The effective cost of the bank loan (44.93%) is much higher than the cost of not taking supplier discounts; thus, Stewart should minimize bank borrowing and maximize the use of trade credit, **but** must comply with supplier terms. - The pro forma balance sheet reflects higher cash (compensating balance), prepaid interest (discount interest), and a shift from payables to notes payable. --- **If you need a more detailed calculation or further breakdown for each line item, let me know!**

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