CASE: PADGETT PAPER PRODUCTS COMPANY
As result of inflation and the acquisition of its competitor, Tri-State Tablet Company in 1996, Padgett's financial needs have been risen to a permanent level rather than being merely seasonal in nature. The Company exceeded its bank credit line of USD 5 million to USD 7.2 million. So Padgett Paper requested their bank, the Calson Trust Company for a higher credit limit of USD 8 million. The request was granted under internal guidance line of USD 8 million at prime. The objective is for the Management at the company's bank must revise Padgett's debt structure in a mutually satisfactory manner that will minimize lender risk while increasing company value. The current situation is the bank is now in bad situation because of over extended. Lending exceeds reasonable levels and is not collateralized. A credit line of USD 8 million is not normal for the bank. Furthermore the Companies management does not appear to understand the unrealistic debt situation and has unrealistic expectations and a lack of understanding of impact of current structure of firm values and impacts on the upcoming audit reports. Another issue is that the Owner of the Company is interested in dividend distribution, which is another reason for the bad debt structure of the Company. Padgett could repay the loan after 8 years which was considerably longer than the typical bank five-year term loan that a company like Padgett Paper's size might expect under the assumption that the company would generate every subsequent year at a Cash Flow of USD 1 million. The company has significant levels of Equity and is not minimizing its financial structure. It is able of taking more debt, but the debt needs to be more properly structured. The D/E ratio during the years increased significantly. In 1993 the D/E ratio was 22% and in 1996 it grew at 67% (Appendix1). Also the Comparison of the total Equity and the total Liabilities show that the share of Equity of Liabilities was between 1993 to 1996 to high. (Appenix1) The Company had too much short-term debt, from the year 2005 to 2006 and had an increase of 131, 6% (Appendix1). The whole structure of the total Liabilities demonstrate the unstructured and unequally relation. (Appendix1). Through this the Company reached a lost from tax shield value. Because of the low amount of the long- term debt the company had not a huge amount of interest expenses which it would deduct of the Operating profit (EBIT). Therefore the Company has to tax the whole EBIT. The Income Statement shows that the Tax made almost 57% of the EBIT in 1993 and in the further years the tax alternate between 52% and 42% was very high (Appendix1). This means that the big amount of Equity which the Company had generated was too small of a profit which the tax shield lost. Libris who was the vice president of the Calson Trust Company understood the problem and offered the Company insurance financing. He proposed a 12- to 15- year loan under a fixed rate of 9.5%. The bank would continue to provide for Padgett's seasonal working-capital financing on a floating prime- rate basis which would be approx. 0, 5%. Padgett refused this first agreement. The management did not like the idea of an elaborate set of covenants. After that Libris took a closer look at Padgett's business and entitles and prepared a new set of forecasts for Padgett's books, thus regaining trust from the Padgett Management. Libris proposed to adopt for 1997 fiscal year to change the Inventory valuation from FIFO to the LIFO method. It would save more cash than the cost of implementing the system and would result in a tax deferral of USD 500,000 thousand but it will be difficult to implement and administer, however it is necessary for the company to do this. Furthermore he proposed to dispose of redundant warehouses that had been part of the Tri-State acquisition. The Management expected to receive USD 700,000 thousand from the cash sale and tax...
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