Key questions and concepts that your team should address:
Why has Clarkson Lumber Company borrowed increasing amounts despite its consistent profitability?
In order for Clarkson to keep up with an increase in sales, they need to borrow additional funds to increase their purchase order sizes.
How has Mr. Clarkson met the financing needs of the company during the period 1993 through 1995? Has the financial strength of Clarkson Lumber improved or deteriorated?
During the last 3 years, Clarkson has used its line of credit with Suburban National Bank ($400k) and cash flow from operations to support its operations in addition to paying off its Holtz loan and term loan. During this period, Clarkson’s financial strength has deteriorated significantly. Below are a few examples of their declining strength:
How attractive is it to take the trade discount?
On a net basis, the trade discount of 2% is offset by the borrowing rate of 11%. However, since Clarkson’s profits are driven by volumes, their line of credit allows them to continue their growth in sales. Based on our calculations, for Clarkson to achieve $5.5 million in sales in 1996, they would only be able to purchase 95% of their cost of goods sold from their $750k credit line.
In the long term, growth in sales will be inhibited by Clarkson’s cash balance to purchase Cost of Goods sold. The net income from its sales is not enough to support the requirement to pay the Holtz loan and account for their upward increase in sales.
Do you agree with Mr. Clarkson’s estimate of the company’s loan requirements? How much will he need to finance the expected expansion in sales to $5.5 million in 1996 and take all the trade discounts?
To achieve $5.5 million of sales in 1996 and take advantage of all trade discounts, Clarkson will need to borrow approximately $800k....
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