Royal Company has incurred substantial losses for several years and is in solvent. On March 31, Year 5, Royal petitions the court for protection from creditors and submits the following balance sheet:

Royal's management informed the court that the company developed a new product and a prospective customer is willing to sign a contract for the purchase of (at a price of $90 per unit) 10,000 units during the year ending March 31, Year 6; 12,000 units during the year ending March 31, Year 7; and 15,000 units during the year ending March 31, Year 8. The product can be manufactured using Royal's current facilities. Monthly production with immediate delivery is expected to be uniform within each year. Receivables are expected to be collected during the calendar month following sales. Production costs per unit for the new product are as follows:
Direct materials . . . . . . . . $20 Direct labor. . . . . . . $30 Variable overhead . . . . $10
Fixed costs (excluding depreciation) amount to $130,000 per year. Purchases of direct materials are paid during the calendar month following purchase. Fixed costs, direct labor, and variable overhead are paid as incurred. Inventory of direct materials are equal to 60 days' usage. After the first month of operations during which Royal will order 90 days' supply, 30 days' usage of direct materials is ordered each month.
Creditors have agreed to reduce their total claims to 60% of their March 31, Year 5, balances under two conditions:
1. Existing accounts receivable and inventories are liquidated immediately with the proceeds going to creditors.
2. The remaining balance in accounts payable is paid as cash is produced from future operations-but in no event is it to be paid later than March 31, Year 7. No interest is paid on these obligations.
Under this proposal, creditors would receive $110,000 more than the current liquidation value of Royal's assets. The court engages you to determine the feasibility of this proposal.

Prepare a cash forecast for years ending March 31, Year 6 and Year 7. Ignore any need to borrow and repay short-term funds for working capital purposes and show the cash expected to be available to pay creditors, the actual payments to creditors, and the cash remaining after payments to creditors.

  • CreatedJanuary 22, 2015
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