Ivan Petrov is searching for BGN 25,000 to purchase a Buttonhole Sewing machine. The machine is the final production-line piece of equipment necessary for the successful start-up of the sewing factory established by Petrov. The machine is a vital piece of professional equipment for the production of sports coats in which Petrov will specialize. The machine guarantees quality workmanship along with decreased production times, which are essential preconditions for receiving “Cut, Make, and Trim” (CMT) orders for export.
Petrov lives in Ruse, Bulgaria. Bulgaria is a small country with 8,000,000 people located in Southeastern Europe. Ruse is in the northeastern part of the country 300 km from the Sofia and 200 km from the Black Sea Coast. Ruse has the most significant Bulgarian river port feeding into the Black Sea. As a port city Ruse enjoys a long history as a trading center and textile manufacturing base. However, the transition to a market-driven economy has not been easy with the unemployment rate hovering around 22 percent and banks charging upwards of 18 percent for business loans.
Petrov began his entrepreneurial career in 1993 trading buttons and sewing related products. He expanded rapidly and in 1996 began trading in more expensive items such as sewing machines and related equipment. Petrov’s sales for 1998 were roughly BGN 200,000, but declined to BGN 100,000 in 1999 primarily due to the scarcity of loans to SMEs for new equipment and because industrial sewing equipment is not frequently replaced. At this point Petrov started looking for other opportunities that led him to establishing his most recent venture – the sewing facility. Some of the new machines from his unsold inventory make up part of his current production line
To date, Petrov has tentative agreements with Marisa Textile LTD, Elina Jsc. and Magic LTD for CMT orders that will be exported to the USA, Holland and Germany. Petrov will solidify these agreements once the buttonhole sewing machine is installed in his production line.
Customers provide all the necessary materials needed for CMT orders. The manufacturer’s inputs are thus limited to the sewing equipment and the personnel capable of completing the orders on time at the level of quality desired by the client.
Ivan Petrov has verbal agreements with representatives of CMT suppliers to provide approximately 3,100 sports coats starting in August this year. Prices of CMT sports coats produced in Bulgaria range from BGN 5.50 to BGN 8, depending on the complexity of the model. Petrov bases his financial projections on earning BGN 7.50 per coat.
Petrov is requesting a loan of BGN 25,000 to purchase the necessary machine. He believes an appropriate interest rate is 9% per year with a 5-year payback on the loan.
The Balance Sheet
Petrov presents you with the following balance sheet (assuming the loan is made):
Notes – Cash represents what his friends have promised him if he can get the plant opened. Ivan insists he can pay this money back whenever he wants and it carries a zero interest rate.
Plant and equipment consists of BGN 10,000 in improvements (he painted the facility and added some lights), BGN 47,000 in equipment he had in inventory.
The BGN 47,000 represents the “sales price” of the equipment, Petrov’s actual cost was BGN 30,000 and the equipment could probably be sold quickly for half of his actual cost
The buttonhole machine for BGN 25,000 is also included in Plant & Equipment.
The “know-how” represents what Ivan believes his experience is worth.
Liabilities – the BGN 25,000 is the amount borrowed on the new machine. Paid in Capital is a plug figure.
Petrov’s projected first-year income statement wasbased on the following assumptions:
Sport coat production of 3100 pieces per month earning BGN 7.5 per coat, Note – Petrov signed contracts for 1 000 pieces per month at BGN 5.5 per piece, the remaining 2100 units represents what Petrov “hopes” to get.
Total capacity 3100 pieces per month. Employee salaries are 30 employees with an average monthly salary of BGN 205 each. Administrative salaries do not depend on the level of production
Every July the facility closes down for maintenance and vacations. No revenue will be earned during this period but the firm will continue to incur operating costs. Assume the first month of operation with the new machine is August.
Employee transportation to and from the facility of BGN 750 per month
Electricity consumption based on producing 3100 pieces per month.
Telephone bills based on expected use. Approximately BGN 200/month
Depreciation = 5 year straight line method
Security includes payments for a security system and guards
Interest rate on the loan = 9% per year, this is what Petrov believes is reasonable – banks are currently charging 18% per year for lending to small firms.
Loan term = 5 year payoff, monthly payments
Tax Rate 35%,
Loan Amortization Schedule
1) What do you think of Petrov’s pro forma financial statements? Do you see any unintended consequences in presenting this set of projections to a bank?
2) Recalculate the current balance sheet to reflect the additional information.
3) What errors/omissions do you find in the above projected income statement?
4) Develop monthly projections (income statement & cash flow) for the first year of operations based on the existing forecast (use the format in the attached spreadsheet).
5) Develop monthly projections for the first year of operations based on the additional data.
6) Develop a projected balance sheet for the end of the first year assuming the existing projections & the revised projections.
7) Based on the available information would you grant the loan? If not, please come up with an alternative proposal.
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