Case 1: Clarkson Lumber
As a financial consultant to Clarkson Lumber, I analyzed four potential scenarios with relatively high probabilities of occurring given Clarkson Lumber’s current situation. The four scenarios analyzed are continued rapid growth of Clarkson Lumber with Suburban Bank as the creditor, slowed growth with Suburban Bank as the creditor, continued rapid growth with Northrup Bank as the creditor, and controlled rapid growth with Northrup bank as the creditor.
Clarkson Lumber’s first scenario is one of continued rapid growth with Suburban Bank as the creditor and is represented by tables 1, 1.2, and 1.3. Using the most relevant expectation of about five and a half million dollars in 1996 net sales for Clarkson Lumber, as given by Northrup Bank’s investigator along with historical income statement data, I found that an annual growth rate of 22 percent was reasonable this scenario. Rapid growth of 22 percent applies during 1996, 1997, and 1998, before dropping to a sustainable annual growth rate of five percent thereafter. To achieve the expected growth rate of 22 percent for the next three years, Clarkson Lumber must continue capital expansion through 1997 that began in 1995 after rapid growth has begun a few years earlier. Continued capital expansion is mandatory because Clarkson Lumber seems to be at sales capacity. Expansion will require 14 cents of investment for every dollar of net sales growth at a growth rate of 22 percent. In addition to costs for expansion, variable costs, fixed costs, and capital replacement will increase at their historical ratios and levels relative to the growth rate in a rapid growth situation. Finally, substantial increases in working capital will be required to manage inventory and accounts payable along with any possibility spontaneous accruals or needs for cash (which I assumed would not be spontaneous). This scenario assumes that Clarkson Lumber will keep its future w-factor close to the historical levels by continuing to take full advantage of payable trade accounts to lower the need for working capital.
My conclusion for this scenario is that the situation is unsustainable given the current credit ceiling of $400,000 from Suburban Bank. Taking into account the costs of rapid growth explained in the previous paragraph, Clarkson Lumber would need to stop any growth sometime during 1996. Table one shows gross debt increasing from $610,000 to $842,000, an increase of $232,000. From my calculation of Clarkson Lumber’s debt situation, it is limited to only nine thousand dollars of debt increase with Suburban Bank, which the company reaches in the first quarter of 1996 according to the balance sheet. This situation is undesirable because Clarkson Lumber would be limited to very slow growth by Suburban Bank.
A scenario of slow growth with Suburban Bank as the creditor is the next situation analyzed and will be represented by Tables 2, 2.2, and 2.3. This scenario assumes an economic slow down and the slow down of the once rapidly growing suburb Clarkson Lumber operates within. Because of the nature of Clarkson Lumber’s repair business the case book mentions; slow growth of five percent would be expected for the company, instead of a flat or negative growth rate. Because of the slow growth rate, the inflator for Clarkson Lumber is set to the inflation rate of four percent, limiting growth rates of variable costs, fixed costs, and capital replacement. Because of the low growth rate, working capital needs will become almost flat and there will be no expansion costs within the foreseeable future. Further, in this scenario I would expect Clarkson Lumber to take advantage of some trade discounts and avoid using payable trade accounts as cash and credit become available while gross debt is paid off, moving the v-factor down to 73.5 percent and the w-factor up to 16.5 percent.
While slow growth due to an economic downturn is always bad news for a company that...
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