Reserves: In this assignment you will develop best and worst case scenarios for your next round. You need to balance two risks -- the risk of missed sales because of stock outs, and the risk of building too much inventory. In your worst case, competition is fierce and you end up carrying lots of inventory. In your best case, you sell everything but one unit on each product. If you add the Balance Sheet's Cash and Inventory together, you get a sense for the reserve portion of your current assets. A big reserve earns you nothing, not even bank interest, and costs you interest expense and (in the case of inventory), carrying costs. . Therefore, you want to keep the reserve as small as possible. With a perfect forecast, your reserve could be tiny. Better forecasting = smaller reserve. The simulation prepares a set of proforma financial statements automatically. These can be used to develop a best/worse case set of scenarios. First you need a method to develop a best/worst case for a product. You will find a discussion in the Team Member Guide, Chapter 10. There is also a tutorial How to Develop a Sales Forecast. Start by entering decisions as usual. Develop a set of decisions for each product in R&D, Marketing, and Production. As pointed out in the tutorials, the computers unit sales forecast is unreliable, because the computer does not know what competitors have done. Instead it assumes a mediocre product from every competitor in every segment. The computers forecast is useful for sensitivity analysis. For example, if you drop price 10% and observed a 15% increase in unit sales, that relationship will hold unless your competitors also drop the price 10%. Develop a worst-case unit sales forecast for each product. That is, you want to be able to say, This products sales could not reasonably be any worse than this number of units. Enter the values in the Sales Forecast column. Examine your Balance Sheet. If your Cash is negative, use Current Debt to bring Cash to a small positive. In your worst case scenario you have a little Cash and lots of Inventory. Examine your Income Statement. You will observe worst-case sales and profits. This is as bad as it can get. Save your decisions. Return to the Marketing Spreadsheet. Enter your best case forecast. Observe that your Balance Sheet will now reflect lots of Cash and no Inventory. The Income Statement will show your best possible Sales (you are selling everything) and your best possible profits. You are now prepared to set several important policies. In your response to this question, obtain the following from your proforma financial statements: 1. Record Cash and Inventory from your worst case. How much do they total? 2. Record your best and worst case numbers for Sales. What is the spread between them? For example, in your worst case, total sales might be $120M. In the best, $150M. The spread is $150M - $120M = $30M. Another way to look at this would be in months of sales. $30M/$120M = .25 years or 3 months. Your policy, then, is to carry sufficient reserves to survive a three month build up of inventory. 3. How much does this spread cost you? ? Idle cash could be used to pay down debt or improve plant. Inventory carry costs eat into profits. Estimate the cost of the spread as follows. Add together Cash and Inventory. Multiply this by your current short-term debt rate. Add the Inventory Carry Cost from your worst case. Record the result. 4. Suppose you narrowed the spread from say 3 months to 1 month. This would save you the cost of carrying large working capital reserves, but if you were wrong on the downside, you would run out of cash and take an emergency loan. What policy, expressed as months, would you set for your company's reserves? 5. Suppose you narrow your spread and then stock out. What is the opportunity cost of one month of missed sales? (Remember, your fixed costs were already covered by the sales you did make. Therefore, an additional month of sales would only incur the cost of goods. No marketing, R&D, or depreciation expense are felt because those have already been paid for by the units you did sell. Even the Interest payments have been made.) For example, if your sales were $120M, in one month you sell $10M. If a months material and labor costs are $7M, you missed contributing $3M to Net Margin. This would be taxed in the simulation at 35%, so your opportunity cost is a missed $2M in profit