It is late summer and General Wheels, Inc., an auto manufacturer, is facing a financial crisis. A large issue of bonds payable will mature next March, and the company must issue stock or new bonds to raise the money to retire this debt. Unfortunately, profits and cash flows have been declining over recent years. Management fears that if cash flows and profits do not improve in the current year, the company will not be able to raise the capital needed to replace the maturing bonds. Therefore, members of management have made the following proposals to improve the cash flows and profitability that will be reported in the financial statements dated this coming
1. Switch from the LIFO method to the FIFO method of valuing inventories. Management estimates that the FIFO method will result in a lower cost of goods sold but in higher income taxes for the current year. However, the additional income taxes will not actually be paid until early next year.
2. Switch from the 150 percent declining-balance method of depreciation to the straight-line method and lengthen the useful lives over which assets are depreciated. (These changes would be made only for financial reporting purposes, not for income tax purposes.)
3. Pressure dealers to increase their inventories—in short, to buy more cars. (The dealerships are independently owned; thus dealers are the customers to whom General Wheels sells automobiles.) Management estimates that this strategy could increase sales for the current year by 5 percent. However, any additional sales in the current year would be almost entirely offset by fewer sales in the following year.
4. Require dealers to pay for purchases more quickly. Currently, dealers must pay for purchases of autos within 60 days. Management is considering reducing this period to 30 days.
5. Pass up cash discounts offered by suppliers for prompt payment (that is, 2/10, n/30), and do not pay any bills until the final due date.
6. Borrow at current short-term interest rates (about 10 percent) and use the proceeds to pay off long-term debt bearing an interest rate of 13 percent.
7. Substitute stock dividends for the cash dividends currently paid on capital stock.
a. Prepare a schedule with four columns. The first column is to be headed “Proposals” and is to contain the paragraph numbers of the seven proposals listed above. The next three columns are to be headed with the following financial statement captions:
(1) “Net Income,”
(2) “Net Cash Flows from Operating Activities,” and
For each of the seven proposals in the left-hand column, indicate whether you expect the proposal to “Increase,” “Decrease,” or have “No Effect” in the current year on each of the financial statement captions listed in the next three columns.
b. For each of the seven proposals, write a short paragraph explaining the reasoning behind your answers to part a.