Butler Lumber Case Study Analysis Essay

Subject pantryman log familyProblem Whether Mr. home run Butler should go ahead with financing from Northrop internal strand or should stay with Suburban National confide.Options 1) Enter into a bestow agreement with Northrop National Bank for USD 465,000 (Assumption The condition to sever the race with Suburban National Bank applies to Short Term Loan only) 2) celebrate pithy end point lending relationship with Suburban National Bank for USD 250,000 and secure the confederations loanword with real property pass Given available data, Butler Lumber go with should enter into a loan agreement with Northrop National Bank for USD 465,000AnalysisOur recommendation to Mr. Mark Butler to enter into agreement with Northrop Bank for line source of USD 465,000 is base on the pursuit factorsExternal Financing NeedWe assessed the smart sets external financing gather up in 1991 based on the following scenariosa)The current quarter remuneration gross sales of 1991 attributes 2 6% of annual sales of company in 1991, since first quarter sales of 1990 contributed 26% of resume 1990 net sales and and so the total net sales intercommunicate for 1991 is USD 2.77 Mn. Balance Sheet and Income statement have been project at dowery of sales (Please refer to exhibit no. 1). In this scenario, we assume company doesnt opt to coming back discounts on its purchases b) dinero gross revenue of USD 2.77Mn, company opts to take discounts on its purchases c)Net sales in 1991 of USD 3.6Mn as bear witnessd by banks investigator in the case studyUnder both the supra scenarios, company would need more financing than its current bank credit facility of USD 250,000.Under scenario (a), if the company decides not to take discounts, and then it would need short end point credit facility of USD 211,000 to meet its short terminal nifty requirements, however companys accounts payables would increment to USD 263,000 and its net wampum depart be USD 49,000. Hence as far compa nys financing need is concerned it can continue its short term relationship with the existing bank. On the other hand, if the company decides to take discounts, then it would need short term loan of USD 407,000 to meets its running(a) capital requirements and hence would have to go into agreement with the mod bank. Under this scenario, companys accounts payables would amount to USD 55,000 and net profit would be USD 61,000.Under scenario no (b), Butler Lumber total assets are intercommunicate to outpace total liabilities (excluding short term loan) by USD 628, 000, hence the existing loan will be far from fulfilling clients working capital needs and the loan from Northrop Bank will be able to bridge USD 465,000 of the gap, however company would still be needing USD 162,000 under current mode of operation. We recommend that isolated from getting current line of credit from Northrop Bank, company should scale down its days receivables period.Increase in ProfitabilityOption 1If the company clay with the existing bank loan, the total recreate expenses are projected to change magnitude by USD 7,000 in 1991 and resulting into after-tax net profit USD 49,000 with loan from existing bank. The good rate of interest expense is 13.2% with existing loan. (Please refer to exhibit _____)Compared to 1990, ROA will anticipate the same at 5% and roe will remain at 13%.Option 2If the company replaces its short term line of credit from its existing bank to late bank, the total interest expenses are projected to increase by USD 11,000 in 1991, however company will be able to earn discounts of USD 27,000, resulting into after-tax net profit of USD 61,000 with parvenufound loan as compared to after-tax net profit of USD 49,000 with loan from existing bank. The rough-and-ready rate of interest expense with new loan, after taking aftermath of discount income, is 5.0% compared to 13.2% with existing loan. (Please refer to exhibit _____)Compared to 1990, ROA will incre ase to 6% while ROE will increase to 17%. These profitability ratios indicate a better result by taking up the new loan than staying with the old bank. By Dupont analysis (Please see exhibit___), the main drivers for the higher(prenominal) ROE for new loan is callable(p) to higher profit adjustment which offset the lower equity multiplier. The effect of the discount income has driven the profitability, which in turn reflected also in the ROE and ROA ratios.Changes in Flexibility with the new loanDecreasing Flexibility in Managerial DecisionsThe company becomes little flexible in its managerial decisions by taking up the new loan. It would be bounded by the negative covenants imposed by the new bank. These negative covenants place clear restrictions to Butlers future managerial decisions, including investments in fixed assets and limited withdrawals of funds. Because of Butlers conservative operational so far, he should be able to deal with these restrictions. Furthermore, Butle r Lumbers increased sales are shielded from the general economical downturn to some degree due to the relatively large equipoise of its repair telephone line. This will facilitate the maintenance of the net working capital even in a general economic downturn stage.As additional part of the covenants the bank placed importance on the net working capital. This could have positive impact to the unanimouss future. As the firm is affected by runniness problems, the covenants on net workingcapital will make Butler to be more remindful about firm liquidity in midst of sales expansion. Thus, it could reduce the chance of Butler ending back with a situation of liquidity issues.Increasing Flexibility in Financial OpportunitiesBecause companys business is seasonal, the financial opportunities by the new loan offer scope to rest period seasonal variations. Another point is the now possible use of discounts provided by suppliers (see Increase in Profitability section).Ratios (please refer to exhibit ___)Option 1 If Butler Lumber stays with the old bank we can conserve a constant economic value, from 1990 to 1991, for net working capital, current and quick ratio. At first glance, seems that the firm is able to cover current liabilities with current assets, but, without the farm animal (which takes more time to convert into cash), the situation is completely different. The D/E increases from 1,68 to 1,72, while the interest coverage presents a value, that, even if lower, is acceptable. With regard to the profitability, the ROA and the ROE remain constant. The cash cycle increases from 64 to 72 this is due to an increase to both inventory and receivables period, even if we can observe an increase in the payable as well.Option 2 Taking the new loan lead to an increase in net working capital, mainly due to the reduction of current liabilities (in fact, despite the increase in notes payable, there is a drastic reduction in accounts payable, in order to get the discount) . In this scenario both current and quick ratio improve, indicating an improvement in firms liquidity. The D/E belittles from 1,68 to 1,62 and the interest coverage presents an acceptable value as well. Unlike scenario (a), profitability improves in a consistent panache ROA increases to 6% and ROE increases to 16%. The cash cycle rises significantly due to the combined effect of increase in inventory and receivables period and decrease in payable.AppendicesExhibit 1 projected income statement and balance canvas tentProjected income statement19901991USD in millions, FYE 31-DecActual% of Sales Scenario a-1Scenario a-2Scenario b Net sales12,694100.00% 2,7712,7713,600COGS set out Inventory326418418418Purchases2,0422,0182,0182,7462,3682,4362,4363,164Ending Inventory241815.52%430430559Total COGS21,95072.38%2,0062,0062,606GROSS PROFIT744 765765994Operating expenses365820.90%667667840Interest expenses433N.A405151Discounts 2742NET INCOME originally TAXES53 5874145Provision for income tax es59101437NET INCOME44 4961107Projected balance sheet19901991USD in millions, FYE 31-DecActual% of Sales Scenario a-1Scenario a-2Scenario b Cash2411.52%424255Account receivable, net231711.77%326326424Inventory418430430559CURRENT ASSETS776 7987981037Property, net21575.83%161161210TOTAL ASSETS933 9609601247Notes payable (bank)6233N.A247407465Notes payable (Mr. Stark)0N.A000Notes payable, trade0N.A000Accounts payable22569.50%2635575 increase expenses39N.A393939L-t debt, current portion77N.A777CURRENT LIABILITIES535 556508586L-t debt750N.A434343TOTAL LIABILITIES585 599551629Net worth348N.A348348348Retained earnings84961107New Net Worth397409455TOTAL LIABILITIES & NET WORTH933 9969601084PLUG EFN -360162Scenarios-a-1 refers to projected sales of $2,771m in 1991 and a continuing relationship with Suburban National Bank -a-2 refers to projected sales of $2,771m in 1991 and a new relationship with Northrop National Bank -b refers to projected sales of $3,600m in 1991 and a new relationship w ith Northrop National BankNotes1 Q1 1991 sales are $718m. Q1 1990 sales were 25.91% of FY 1990 sales. We assume this ratio to be constant in scenario a. In scenario b, we rely of Northrop National banks assumption of $3,600m sales in 1991.2 Assumed to be percent of sales.3 Operating expenses includes Mr. Butlers salary. Operating expenses are projected by decreasing in operation(p) expenses of 1990 by $95K (salary) and applying percentage of sales to the operating expenses without salary, then adding back $88K (annualised Q1 1991 salary) to get the operating expenses of 1991.4 As a corporation, Butler is taxed 15% on its first $50,000 sales, 25% on the bordering $25,000, and 34% on all additional income above $75,000.