Statement of firm’s position
Butler Lumber Company is looking for more cash due to a fast-paced lumber market and a shortage of funding. Their regular bank, Suburban National Bank, is not willing to expand their exiting loan to an amount greater than $250,000 without securing the loan with real property. Another loan is being offered by a second bank, Northrup National Bank, for $465,000, with the understanding that the previous loan would be rolled into the second. The interest on the new loan would be prime + 2%.
The co-founder, Mark Butler, owes a major note to the other original partner, who Mark bought out. He has a mortgage on his 12-year-old house and no other significant investments. Mark’s personal references indicate that he is hard-working and watches his business very closely.
Mark’s current outstanding debts are as follows:
Bank note for $247,000
Outstanding debt from trade partners $157,000
Accounts payable $343,000
Accrued expenses $51,000
Current portion of long-term debt $7,000
Long-term debt $43,000
Total liabilities $848,000
Net income is projected at $56,000 based on projected sales of $3.6m. Butler’s business relies more heavily on the repair industry than on new construction, so it is somewhat protected against market fluctuations on new construction.
Northrup National Bank should extend the loan to Butler. The company will roll much of its existing debt into the new loan, without extending itself significantly further than it currently is, and at a more favorable rate. Butler has been successful in keeping current on its debts, and based on projections should have the means to start paying these debts down. From the bank’s perspective, there’s little risk involved. With the industry expected to grow so much in the next year, Butler will be in a strong position, and potentially interested in borrowing more at the end of 1991.
Butler Lumber Co. should take the short term loan and if necessary roll the $157,000 trade credit into it.
Nature of the problem
Butler’s short-term loan options are completely maxed out, so the company has no cash flexibility. Inventory levels indicate Mark is ramping up in expectation of the massive influx of sales in the warmer months. More of Butler’s sales are in the warm months, when repairs are easier to make in the Inland Northwest. The loan will give Butler the ability to finance more inventory to meet the expected growth in sales.
Why does Mr. Butler have to borrow money to support his profitable business? Theoretically, according to the balance sheet, no additional funding is necessary to meet the growth in sales in 1991. In fact, the balance sheet shows that Mark can pay down his debt by $33,000. However, there are advantages to borrowing additional funds to improve his cash flexibility and to consolidate his debt at a lower interest rate.
Do you agree with his estimate of the company’s loan requirements? Butler can meet their expected sales without additional funding. If the goal is to eliminate the trade debt, while maintaining the current bank note at $247,000, Mr. Butler would need an additional $124,000, the remaining balance after subtracting $33,000 from the trade credit of $157,000. But the current bank will not offer this additional funding, which would then come to $371,000, resulting in the discussions with Northrup.
As Mr. Butler’s financial advisor, would you urge him to go ahead with or reconsider his anticipated expansion and his plans for additional financing? We feel that Butler should go ahead with the anticipated expansion because the business is profitable and growing. However, as shown above, this will require additional working capital to meet his current obligations to his lender and suppliers. Current liabilities total $404,000, so the credit line under consideration will provide additional financial flexibility, which is needed...
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