Chapter 9, Problem 9.58AP

Cash budgets under two alternatives (Learning Objectives 2 & 3)

Each autumn, as a hobby, Hannah Olson weaves cotton placemats to sell at a local craft shop. The mats sell for $30 per set of four mats. The shop charges a 20% commission and remits the net proceeds to Olson at the end of December. Olson has woven and sold 26 sets in each of the last two years. She has enough cotton in inventory to make another 26 sets. She paid $8 per set for the cotton. Olson uses a four-harness loom that she purchased for cash exactly two years ago. It is depreciated at the rate of $5 per month. The accounts payable relate to the cotton inventory and are payable by September 30.

Olson is considering buying an eight-harness loom so that she can weave more intricate patterns in linen. The new loom costs $1,000; it would be depreciated at $20 per month. Her bank has agreed to lend her $1,000 at 18% interest, with $200 principal plus accrued interest payable each December 31. Olson believes she can weave 16 linen placemat sets in time for the Christmas rush if she does not weave any cotton mats. She predicts that each linen set will sell for $65. Linen costs $20 per set. Olson’s supplier will sell her linen on credit, payable December 31.

Olson plans to keep her old loom whether or not she buys the new loom. The balance sheet for her weaving business at August 31 is as follows:

9.4-59 Full Alternative Text

Requirements

1. 1. Prepare a combined cash budget for the four months ending December 31, for two alternatives: weaving the placemats in cotton using the existing loom and weaving the placemats in linen using the new loom. For each alternative, prepare a budgeted income statement for the four months ending December 31 and a budgeted balance sheet at December 31.
2. 2. On the basis of financial considerations only, what should Olson do? Give your reason.
3. 3. What nonfinancial factors might Olson consider in her decision?