WASATCH ELECTRONICSFinancial Analysis and PlanningEXHIBIT IWASATCH ELECTRONICSPro Forma Balance SheetEXHIBIT IIWASATCH ELECTRONICS2000 SALES FORECASTTypical PercentageWASATCH ELECTRONICSFinancial Analysis and PlanningBob Hosfeld, Chief Financial Officer for Wasatch Electronics, received a phone call inearly January, 2000, from Sam Weaver, a commercial loan officer at Wasatch's bank, PioneerNational Bank of Salt Lake City, Utah. Mr. Weaver explained that the bank was asking all of itsmajor customers to estimate their loan needs for the next five years. He explained that thisforecast was necessary for bank planning purposes and for insuring that the bank's best customers'loan needs would be satisfied. Specifically, he asked Mr. Hosfeld to prepare quarterly estimates ofbank borrowing requirements for 2000 and annual projections thereafter. Since Mr. Hosfeldearlier had decided to extend Wasatch's financial planning period beyond the current three-yearprojection horizon, he agreed to meet with Mr. Weaver the following week to discuss the firm'slonger-range loan needs. Wasatch's management considers the bank line to be the firm's residualfinancing source.Currently, Wasatch has a $150,000 credit line with Pioneer National. Terms of the creditline require that Wasatch maintain a current ratio of at least 1.50 and a total debt-to-equity ratioof less than 0.60. In addition, the bank preferred that Wasatch "clean up" the credit line for atleast one quarter each year, i.e., have a credit line balance of zero for at least three months. Thislatter requirement was an attempt to insure that the credit line was not being used for long-termfunding needs. If any of the covenants are violated, Pioneer has the right, but not the obligation,to "call in" the outstanding loan balance and terminate the credit line agreement if corrections arenot made within one quarter.Wasatch's preliminary (unaudited) December 31, 1999 balance sheet is attached as ExhibitI. The ending cash balance of $70,000 is the minimum level of cash Mr. Hosfeld feels Wasatchshould maintain. Cash surpluses over this amount are used to reduce any existing bank loanbalances. If no bank loan is outstanding, cash balances over $70,000 are invested in short-termtreasury securities. Wasatch's current borrowing rate is prime plus two percent, or 10-3/4 percentper year. Mr. Hosfeld intends to use this rate throughout the five-year planning horizon. Forprojection purposes, Mr. Hosfeld will use the closing quarterly loan balances for 2000 and theclosing annual balances for subsequent years as a proxy for the actual loan balance during thepreceding period.1 Given other estimation errors involved in forecasting, this procedure hadproven adequate in past projections.Mr. Hosfeld obtained a quarterly sales forecast for 2000 from his financial analysis andplanning group. See Exhibit II. This forecast was derived from feedback from salesrepresentatives based upon discussions with customers about their inventory levels andproduction plans. These data supplemented aggregate industry sales level projections from anindustry trade source to which Wasatch subscribed. All of these data were analyzed using aforecasting model designed by Mr. Hosfeld's staff. The projections based upon this model hadproven accurate for one-year forecasts. Beyond one year, however, variations in projected-from-actual sales ranged from plus-to-minus 15 percent. As can be observed in Exhibit II, some1 In other words the closing balance for the 1st quarter of 2000 will be used as an approximation for the loan balance for that quarter. Realistically, interest would be computed and accrued daily based on daily balances for such an account.1seasonality exists in Wasatch's quarterly sales levels. This same relative seasonal variation isexpected to reoccur in subsequent years. Beyond 2000, the most likely scenario is for real salesgrowth (increases in volume sold) to be eight percent per year through 2004. Wasatch's credit personnel estimate that 30 percent of each quarter's sales will be collectedduring the quarter of the sale with the remainder collected during the following quarter. Thiscollection pattern has been remarkably stable in the past. Wasatch's credit terms were set tomatch the competition.Wasatch purchases raw materials in advance of projected needs using a simple orderingalgorithm. Specifically, every quarter they purchase materials necessary to satisfy the estimatedsales need for the upcoming quarter. Raw materials average 45 percent of sales. Therefore,Wasatch acquires raw materials in a given quarter equal to 45 percent of the coming quarter'sestimated sales. Wasatch typically pays for one-half of these purchases in the quarter ordered andthe remaining balance the following quarter. In addition, direct labor expenses run at 10 percentof sales and are paid as realized. Cost of goods sold consists solely of raw materials and directlabor. No overhead items are included in cost of goods sold. Production runs typically arecompleted in one or two days. Finished goods are shipped shortly after completion. Accordingly,no significant work-in-progress or finished goods inventory exists. Sales personnel are paid on a straight commission basis which averages 15 percent ofsales. Administrative expenses are expected to run at $18,000 per quarter for 2000 and areforecast to grow at $2,000 per quarter per year, i.e., $20,000 per quarter in 2001, etc.Commissions and administrative expenses are paid as incurred. Depreciation currently amounted to $10,000 per quarter and will continue at this level onexisting equipment over the planning horizon. New equipment costing $250,000 is scheduled tocome "on line" April 1, 2000. This equipment will provide the firm much needed capacityincreases. In early January 2003, another addition of $300,000 to capacity is planned to meetdemand requirements. Both of these capitalized expenditures will be depreciated quarterly to anestimated zero salvage value over 10 years via straight line depreciation. For each of theseadditions, the equipment manufacturer will be paid at $25,000 per quarter beginning the quarterfollowing installation. No interest will be paid on these loans as an inducement to Wasatch to dealwith this