Toy World Inc

The following assumptions were made in constructing pro forma financial statements for the level production scenario (Exhibit 1):

• Net sales. The alternative production scenario will not influence sales. So net sales will be the same as in the seasonal production scenario.

• Cost of goods sold Under level production, savings in overtime wages ($225,000) and direct labor ($265,000) reduce the percentage of cost of goods sold to sales from 70% to 65.1%.

• Operating expense. The level production scenario will incur an additional $115,000 of storage and handling costs and are accounted for as operating expenses.

• Interest expense. Since the company has the policy of repaying its debts promptly (within 30 days), interest expense for each month is the amount of interest the company owes on the debts outstanding during the previous month. These debts basically consists of two parts: long-term debt and notes payable . Long-term debt is relatively stable ( a $25,000 payment is to be made every June and December) and interest rate is 9.625% (compounded annually). The amount in notes payable will depend on how much money the company has to borrow to support its production each month. If sales during any particular month exceed the need for cash, notes payable will be zero and any additional earnings will accumulate in the cash balance. Interest rate for notes payable under $2 million is 9% per annum.

• Interest income. Interest income for each month is 4% per annum on the cash balance of the previous month.

• Taxes are calculated at 34%.

• Cash. Cash balance has to meet the minimum required balance of $200,000 each month. Any shortage will result in borrowing from the bank while any surplus will cause interest income to increase.

• Accounts Receivable. Accounts receivable is directly connected with sales, and as sales remain the same under both production plans, so does the value in accounts receivable.

• Inventory. The calculation of inventory is connected with...