Title Chemalite, Inc. (B) Cash Flow Analysis.pdf ✅

9-195-130 REV: JUNE 12, 2017 Doctoral Candidate Anthony Davila prepared this case under the supervision of Professor Robert Simons as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 1994, 1995, 2017 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800- 545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. ROBERT SIMONS ANTHONY DAVILA Chemalite, Inc. (B) Cash Flow Analysis Bennett Alexander, a chemical engineer, founded Chemalite, Inc. in late 2002. The company was set up to manufacture and sell his latest patented invention, the Chemalite. The first year of operations was successful, allowing Chemalite's directors to declare a $10,000 dividend at the end of 2004. Exhibit 1 presents the income statement and balance sheet for the year ended December 31, 2004. During the meeting with the company shareholders, held in January 2005, Alexander was congratulated for the company's performance during its first year of operations. After much discussion, the shareholders approved moving the production facilities to a larger location to support expanding sales. They hoped that Chemalite could build market share before any competing product reached the market. They also approved expanding the product line to include new colors. The shareholder meeting ended with a decision to meet during late March to review the performance of the company and study the projected financial statements for 2005. To prepare for the March meeting, Alexander asked his accountant to provide him with the expected financial statements for the year ending December 31, 2005. Exhibit 1 reproduces the report that he received from the accountant. In addition to this report, the accountant provided the following notes: 1. According to our marketing people, sales during the year are expected to increase 150% as we continue to build market share. Half of this growth is expected to come from new wholesalers. Our limited experience with this channel indicates that even if they are supposed to pay in 30 days, the average is 40 days. 2. We will need to maintain a stock of finished goods to give the required service to wholesalers. 3. The average stock of raw materials is assumed to be $75,450. 4. The land and building for the new production facility will cost $850,000, of which $250,000 corresponds to the land. The facility will be operating at the beginning of July, its expected life is 10 years, and it will be depreciated using the straight-line method for accounting purposes and an accelerated method for tax purposes. 5. The seller of the facility will pass title on June 30 and receive half of the purchase price in cash and the other half in three equal annual installments beginning June 30, 2007.

Chemalite, Inc. (B) 195-130 3 Exhibit 1 2005 Pro-forma Financial Statements Balance Sheet as at December 31, 2004 and 2005 December 31, 2004 (Actual) December 31, 2005 (Pro-forma) Assets Cash $113,000 $ 9,490 Accounts receivable 69,500 139,530 Inventories-raw materials 55,000 75,450 Inventories-finished goods —— 104,680a Prepaid insurance —— 65,000 Property, plant and equipment 212,500 1,120,000 Accumulated depreciation (10,625) (56,000) Land —— 250,000 Patent 100,000 75,000 Total assets $539,375 $1,783,150 Liabilities and Owners' Equity Taxes payable 10,900 9,950 Short term debt —— 200,000 Deferred income taxes —— 26,730 Notes payable (10%) —— 425,000 Long-term debt (10%) —— 510,000 Dividends payable 10,000 12,000 Common stock 500,000 500,000 Retained earnings 18,475 125,470 Treasury stock —— (26,000) Total liabilities and owners' equity $539,375 $1,783,150 Income Statement for the years ended Dec. 31, 2004 and 2005 December 31, 2004 (Actual) December 31, 2005 (Pro-forma) Sales $754,500 $1,886,250 Material (195,000) (452,700) Labor (275,000) (660,000) Rent (50,000) (25,000) Utilities (30,000) (82,000) Depreciation (10,625) (61,625) Gross margin 193,875 604,925 Advertising (22,500) (70,000) Research and development —— (63,250) Insurance —— (32,500) Amortization of patent (25,000) (25,000) Selling and administration expenses (75,000) (195,750) Gain on sale of equipment —— 24,250 Interest expense (750) (58,750) Prototypes (23,750) --- Legal fees (7,500) —— Income before taxes 39,375 183,925 Income taxes (10,900) (64,930) Net income $ 28,475 $118,995 a Finished goods inventory includes $5,000 of depreciation.