Clarkson Lumber Case - Mandatory HBR case PDF

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Clarkson Lumber Case Kshatriya Ankitsingh FIN6315 – Entrepreneurial Finance. 1. Build a “sources and uses of cash summary” or a “cash flow statement” for 1994-1995 showing the total changes in sources and uses of cash for both years combined. What is driving the need to borrow funds in Mr. Clarkson’s profitable business?

Increase in Accounts receivables and inventory, and cash outflow to Holtz is driving the need to borrow funds. 2.What are the trends in inventory turnover, days in inventory, accounts receivables turnover, and days in receivables ratios for 1994-1995? Use end of period balances in the calculation to keep it simpler (although average balances are generally better to use).

Account Receivable days have increased implying that Clarkson Lumber Company in 1995 is not collecting money as quickly as in 1994. Since the company can use accounts cash from receivables for operations, the increase in accounts receivables generates financial burden for the company. Inventory days have increased implying that in 1995 it is taking longer to clear out inventory than it did in 1994.

3.Do you think the company’s financial condition has strengthened or weakened since 1993? Why or why not?

Turns ratios (Calculated in question 2), Liquidity ratio, and profitability ratios have decreased over the period 1993 - 1995. Hence, the company's financial position has weakened.

4.Based on the data provided, estimate the sustainable growth rate for 1996 (i.e., the maximum growth rate that can be achieved with no additional equity financing), assuming the company maintains its debt/equity ratio, has no change in the ratio of sales to total assets, does not issue equity, and does not pay dividends SGR = ROE x retention rate / (1- ROE* retention rate) Since no dividends are payed, retention ratio = 1 Therefore, SGR = ROE / (1-ROE) ROE = ROS * S/E If the ratios are assumed to remain same as in the first quarter, then ROS = 0.47%, and Sales to Net Worth =1062/452 = 2.34 ROE = 2.34 *0.47% =1.099% ~1.1% SGR = 1.1/98.9 = 1.11% If the ratios are assumed to remain same on average (of the last three years), then ROE = 15.77% (Average of the ROEs calculated in question 3) SGR = 18.72% 5. Clarkson does not take advantage of discounts offered by its suppliers. What is the effective annual rate (EAR) they are essentially paying for this? Is the decision to not take advantage of the discount wise? Why or why not? i. The general formula for EAR is shown below. ii. EAR = [1+ (quoted rate/m)]m – 1, where m is the number of times per year interest is compounded) iii. How do you calculate EAR for the purchase discount situation? Trade discount offered – 2/10 net 30 Period rate = 2/98 = 2.0408% Period = 30-10= 20 365/20 = 18.25 EAR = 1.020408^18.25 – 1 = 44.54% The discount should be taken if enough cash is available. Since Clarkson did not have enough cash he wasn’t able to take advantage of the discounts. It is wise to take the discount.

6. Assume net income for 1996 is projected to be $110K. Project a balance sheet for 1996 assuming the following: 1. The net income amount mentioned above. 2. All purchase discounts are taken for the period April 1 to December 31, 1996. The other historical relationships and ratios remain about the same as in prior years 4. Use additional debt (Notes Payable, Bank) as the plug to make the balance sheet balance

7. Based on the projection in Question 6, how large of a line of bank credit would Mr. Clarkson need if he wanted to operate the business in the manner discussed in Q6? Total additional funding needed is $1205. However, there is a constraint on interest expense considering the constraint on sales and net income figures. Therefore, the maximum amount that Mr. Clarkson can take as bank credit is $646,000. The rest has to come out of the owner’s pocket. If one doesn’t consider the constraint on sales and uses ratios to compute necessary sales needed, the computed sales is equal ~$6,600 (‘000s) and AFN would be ~$1900 (as per excel computations)...