Case Study: Capital Budgeting
Butler Lumber Company
Butler Lumber Company, a lumber retailer with a rapid growth rate, is faced with the problem of cash flow shortage. In order to support this profitable business, BLC needs a great amount of cash. The loan of $250,000 from Suburban National and a line of credit of up to $465,000 from Northrop National Bank are the two choices provided. After a brief review of the operation and financial conditions of BLC, we first make analysis of the credit level of BLC from the perspective of banker. Although the feedback from all the firms that had business dealings with Butler are quite positive , both solvency and liquidity condition and the mortgage indicates that it is not a wise decision for Northrop National Bank to offer a line of credit to BLC. Then we diagnose the business of BLC by examining the sources and uses of funds and find out that the increase in inventory and accounts payable occupies too much funds that leads to the shortage of cash flow. If BLC can make improvement in the management of these two items, definitely it can take advantage of the trade discount, which equals to an interest rate of 20.2% per year. Based on the calculation of average days payable discount it can be concluded that BLC should reduce its days payable outstanding to 10 days. Since sales is expected to reach $3.6 million in 1991, the projected income sheet and the balance sheet can be obtained through calculation so that we get the plug value (notes payable to bank) needed for the profitable business. This amount is so large that it exceeds the maximum amount the company can get from bank.
In the third part of this report, we provide four suggestions for BLC to solve the problem of cash flow shortage. The credit terms of net 30 days on open account offered to customers can be improved by Customer Credit Ranking System. Besides BLC must keep inventory at an optimal level so that if can save the opportunity cost of occupying funds. The third suggestion we offer is concerned with cash management. Accelerating cash inflow and controlling cash outflow are two major means to decrease the opportunity cost of holding cash. We also suggest BLC to finance through equity so that the liability rate can be reduced to a relatively low level.
Key Words: capital budgeting,
1. Background 1
2. Perspective of Banker 2
2.1 Customary investigation-qualification of the owner 2
2.2 Financial analysis 2
2.1.3 Operating management 4
2.1.4 Assets condition used for securing 4
2.2 Summary 5
3 Perspective of Butler 6
3.1 Sources and uses of funds 6
3.2 Cost of trade discount 7
3.3 Projected Income statements for 1991 8
3.4 Projected Balance sheet for 1991 10
4 Suggestion 12
4.1 Accounts Receivable Management 12
4.2 Downscale Inventory 12
4.3 Cash Management 12
4.4 Equity Financing 13
5 Conclusion 14
As a full service building material dealer serving the needs of industry, contractors, builders and home owners, Butler Lumber Company is in the process of rapid growth. About 55% of total sales were made from April to September, and repair business accounts a relatively high proportion. In order to support this profitable business, BLC needs a great amount of cash.
The maximum loan that the Butler Lumber Company (BLC) could obtain from Suburban National was $250,000 in which his property would be used to secure the loan. Northrop National Bank offered BLC a line of credit of up to $465,000 with many restrictions. BLC would have to sever ties with Suburban National if they were to have this LOC extended to them.
2. Perspective of Banker
From the perspective of banker, it is quite reasonable for Northrop National Bank to put restrictions on the line of credit offered to the Butler Lumber Company. From the investigation carried by the credit department, we can find several points to support our logic.
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