Capstan Autos operates an East Coast dealership for a major Japanese car manufacturer. Capstan's owner, Sidney Capstan, attributed much of the business's success to it's competitive pricing policy and immediate cash payment. The cars are imported at the beginning of each quarter and paid the manufacturer at the end of the quarter. The revenue from the sales are used to pay the manufacturer and the expenses of running the business.
During this time the company had offered a new policy of six months free credit and it was proving that sufficiently popular that Sidney Capstan decided to maintain the policy. In the third quarter of 2010 sales had recovered to 225 units; by the fourth quarter they were 250 units; and by the first quarter of the next year they had reached 275 units. It looked as if by the second quarter of 2011 the company could expect to sell 300 cars. Earnings before interest and tax were already in excess of their previous high, and Sidney Capstan was able to congratulate himself on weathering what looked to be a tricky period. Over the 18-month period the firm had earned net profits of over half a million dollars, and the equity had grown from just over $1.5 million to about $2 million.
Sidney Capstan had always left the financial aspects of the business to the financial manager. However there was one feature of the financial statement that disturbed him. The level of debt by which by the end of the first quarter of 2011 had reach $9.7 million. This unease turned to alarm when the financial manager phoned to say that the bank was reluctant to extend further credit and was even questioning it current level of exposure to the company.
Mr. Capstan thought that once the bank saw the project sales growth for the rest of 2011, it would realize that there were plenty of profits to enable the company to start repaying its loan. Mr. Capstan kept thinking of three questions: Was his company really in trouble? Could the bank be right in...
References: Brealey, R., Myers, S., & Marcus, A. (2007). Fundamentals of Corporate Finance. New York, NY: McGraw-Hill Irwin.
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