BA280.1: Corporate Finance
Case #3: Padgett Paper Products Company
Almera / Demasu-ay / Libo-on / Olaño / Reboton / Relucio / San Luis
Our company, Padgett Paper Product (PPP) is a closely held publicly listed paper manufacturing company whose ownership remained with the descendants of the founder and whose majority of family members was inactive in company’s management. Major connection of these family members came in the form of quarterly dividends.
The current market is being dominated by large companies, and recent events such as inflation, tax rule changes and drop in the stock market caused smaller firms to sell, opening the business for more consolidation. As a response to the market situation and part of our company’s financing activity, we had borrowed small amounts off and on from Caslon Trust Company of Richmond on a short term 90-day notes for minor acquisitions. We took significantly more debt when the company decided to acquire Tri-State Tablet.
Caslon Trust Company has considered us a valued client and a major contributor to its profitability, as our only lending bank in 1997. The bank also serves as depository of the company’s tax payments. Thus, Caslon has been generous in lending us to the point that it allowed exceeding its credit limit with the rate still continued at a prime and with no protective covenants. Potential threat from Phoenix Bank where we had small deposits also led to the loan doubling up to almost $8 million with Caslon without a carefully structured financial program.
To properly restructure our company’s debt, Caslon Trust proposed options that will be beneficial to both and acceptable to Padgett’s management. Initial meetings proved unsuccessful with us refusing to agree to a long term loan through an insurance company financing because of high rates and ‘fancy’ covenants. We don’t have much knowledge of finance so we prefer straightforward options.
The bank prepared a forecast detailing the effects of a 5, 10 and 15% growth of the company, in the hopes to align our goals to theirs. We have also decided to shift to LIFO method of valuation for their inventory for tax purposes, resulting in a $500k tax benefit. In addition, a redundant warehouse will be disposed of giving them an additional $700k from the cash sale and tax refunds. Several alternatives were available to the company in terms of restructuring its loan but we would want something that is simple, straightforward and beneficial for us. Also, the interest rates were pretty volatile – from a low of 6% in the years of 1992-1994 up to 8 1/4% prime for year 1996. Fixed rate would usually entail 2 ½ to 1 % above the floating rate. Our company’s current market standing though allows us to get a competitive rate.
As part of PPP’s management, we need to determine the best option that the company can choose among the alternatives presented by the bank regarding the restructuring of the company’s short term debt. All the options available to PPP will be reviewed, which would include the alternatives cited by Caslon, as well as the other options available in the market that Caslon did not include in his recommendations to us. The effects of each of these alternatives on the Income Statement and liquidity ratios would be quantified and qualified to come up with the optimal capitalization position.
The current capital structure of Padgett makes it difficult for Caslon to continue issuing debt to our company. But the sales of PPP has been growing and is projected to keep growing in the next few years, and the company would be needing more capital to finance their expansion. The main question would be how we would finance this increase in sales – debt or equity? It is apparent that we lean more towards debt as a source of fund since the market considers PPP as illiquid and has a ‘thin market’.
We were using short term,...
Please join StudyMode to read the full document