Butler Lumber Company (Case Study)

Topics: Accounts receivable, Balance sheet, Debt Pages: 7 (1797 words) Published: May 15, 2013

Francis Davidson Tanguay
Paula Zalba
Dounia Tazimezalek
Carl Helou

Applied Corporate Finance
Larbi Hammami
McGill University, Montreal
Tuesday, May 14th, 2013
1. Problem
1.1 Why was sales growth so robust, but net income growth anemic at best? 1.2 Does Mr.Butler need additional funding to fuel his growth? 1.3 Why does butler lumber have a cash shortage problem to begin with? 1.4 Could the cash flows of Butler Lumber support additional debt? 1.5 Should butler lumber sever ties with SNB in order to obtain a larger loan from NNB ? 1.6 Are there alternative solutions to Butler lumber cash shortage problem ?

2. Options
2.1 Status quo.
2.2 BLC severs ties with SNB and obtains a credit line from NNB. 2.3 SNB finds alternative sources of short term funds.

3. Recommendation
BLC should sever ties with SNB and obtain a credit line from NNB.

4. Analysis
Projected income statement for 1991:

Beginning inventory was pulled from the previous year's ending inventory. Purchases were projected from a trend of 75.61% of sales for the previous 3 years. The total cost of goods sold assumed the previous 3-year average of 71.93% of sales would continue. Provision for income taxes was calculated as 15% for the first $50 income, 25% for the second $25 income, and 34% for above $75 income.

Projected Balance Sheet for 1991:

The balance sheet was created by disregarding the fact that butler lumber company needs additional loan. Cash, accounts receivables as well as net property plant were computed based on the average % of sales of the 3 previous years. The same idea was used to determine the projected accounts payables and accrued expenses.

Net worth of Butler Lumber Company was net worth from the previous year and net income from the projected income statement for the last 1991. Based on the pro forma income statement and the balance sheet, it was determined that Butler Lumber Company would need to increase their current debt to $360,000 to continue their expansion as planned.

Financial Analysis:
Put the financial ratios here with the appropriate comment for each table

We will start by assessing of the 2 available options presented for BLC. BLC can remain with SNB by accepting their loan offer for $250000. The only apparent advantage of this option is the fact that a relationship already exists with the bank. This option has a few disadvantages. In fact, it might be possible for BLC to require some additional funds; and the offered loan will become secured signaling the fact that the bank might doubt that Butler will be able to pay back the loan. Despite the fact that Mr Butler will be able to repay this amount, it seems quite obvious that BLC requires a bigger sum of money to sustain its operations given deteriorating liquidity ratios, cash decrease and sales increase.

Alternatively, BLC could choose to take the unsecured 90 days cycle credit line of $465000 at 10.5% interest from NNB. This option offers more advantages to BLC: it is more flexible, it does not require any collateral from Mr Butler and most importantly it offers a larger amount of money. However, if BLC opts for this option, it will terminate the relationship with SNB. Other disadvantages of establishing a LOC with NNB are the restrictions on the company's imposed by the bank.

4.1 Why does BLC have a cash problem ?
As we assess Butler Lumber's operations from 1988 to 1990, we found out that his reliance on trade credit as well as his competitive pricing schema has allowed the company to generate revenues and grow.

Despite the fact that the company was able to generate revenue at an increasing rate during the given years, BLC was unable to accumulate any cash...
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