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Jackson Automotive Systems

Bianco, Cadden, Ciesielka, Loar, Streno Professor Bhattacharya Cases in Finance 30 January 2020 Jackson Automotive Systems Introduction: During June 2013, Heather James was vice president at Michigan State Bank. One of his clients was, Jackson Automotive Systems. Jackson Automotive Systems is a family business run by Larry Edwards. Jackson Automotive is Original Equipment Manufacturer (OEM) located in Jackson, Michigan. Some of their products are: advanced heating and air conditioning systems, engine cooling system and parts, and fuel injection and transfer systems, as well as various other engine parts. Edwards approached James requesting a renewal of an existing loan in the amount of $5 million, scheduled to be repaid the beginning of the month. Jackson wants to borrow an additional $2.4 million to fund the purchase of new equipment, vital to production. The total of these loans ($7.4 million) are scheduled to be repaid on September 30, 2013. Original Equipment Manufacturing (OEM) markets are located all over, but mainly located in Detroit, Michigan. This puts Jackson Automotive right in the middle of the action. There has been exceptional growth and profitability in this field. However, during the 2008 recession, the OEM market declined. Several companies went bankrupt, whereas others declined steadily. Larry Edwards is credited with keeping Jackson Automotive alive throughout the recession through his innovation. Exhibits/Explanation: There are a multitude of reasons as to why profitable companies are unable to repay their loans. Jackson Automotive, specifically, is unable to repay due to a large purchase of treasury stock. Between August 2012 and May 2013 Jackson Automotive purchased treasury stock with their loan in order to retain control. By increasing their percentage of stock, they are increasing the debt on their books. This makes it harder to make monthly interest payments. Additionally, Jackson Automotive is on backorder. This could be due to the fact that Jackson Automotive requires a new machine in order to maintain operations. This machine is incredibly expensive, but the revenue generated from the machine will be greater than the cost. Obtaining this machine will allow Jackson Automotive to generate the profits required in order to pay monthly interest payments. A third reason as to why Jackson Automotive could potentially be having difficulty repaying is due to the state of the economy. Although Edwards led Jackson Automotive through the 2008 recession, there is potential that the ramifications of the 2008 recession did not take effect until now. Finally, one of the biggest reasons includes a quick look at Jackson’s balance sheet. A brief analysis indicates a significant decrease in cash in hand between August 2012 and May 2013. Furthermore, a noticeable increase in Jacksons inventory takes place in April 2013 and continues into May. This drop in cash and spike in inventory cause Jackson’s quick ratio to fall to a concerning 0.58, which shows that the company’s inventory is nearly half of its current assets. This can cause trouble for a company to meet its short term debt obligations and is proven by Jacksons inability to repay its loan.

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Obtaining a new loan will help to purchase vital equipment. Purchasing this equipment will help generate revenues by fulfilling backorders. This is incredibly urgent, as sales are decreasing every month and liabilities due are steadily increasing. The pro forma balance sheet and income statement do have similarities to the cash budgets. Both of these are negative. This is due to the reduction of dividends from income. This can be proven by comparing the receivables to the cash budget. Upon analysis of Jackson’s credit, the company would be able to repay their loans at the end of their fiscal year. After paying the $7.4 million loans to the bank, Jackson will still be carrying a positive cash flow and net income in August. It is not until the following month of September (the final month of the fiscal year) where Jackson runs into cash trouble and holds a negative cash balance. Although it is likely that Jackson can repay its loans, there is still some risk that could cause some trouble. One risk lies in the sales forecast accuracy. If Jackson is not able to reach its sales forecast in the coming months, then they will run into cash shortages to pay off their loans. Jackson increased its sales forecasts for the summer months, especially in June, indicating their confidence. However, these goals need to be met in order to ensure Jackson is safely carrying enough funds to pay off their loans. Both an increase and a decrease in actual sales compared to forecasted sales can cause dramatic fluctuations in Jackson’s future expected cash flows. The sensitivity analysis studies four scenarios, a 10% increase in sales, a 20% increase in sales, a 10% decrease in sales, and a 20% decrease in sales. Any decrease in sales 10% or more will be detrimental to Jackson’s ability to repay its debt, let alone the dividend that it plans to pay. The bank needs to consider this possibility because it can not be certain that Jackson will reach its sales estimates, and if they fall short enough of their estimates then they will not be able to repay the loan. When taking a look at if Jackson Automotive should have the current and additional loan approved depends on their dividend pay out. If they decide to go through with their payout in September, they will have liquidity issues once again. Deciding to not pay out dividends, they will have excess cash in September even with the extension and additional loan amount. However, if they go through with the payout, the bank would be able to approve the extension of the first loan, but would not be able to give the second for the equipment purchase. If the bank does decide to go through with both loans, they must not allow Jackson Automotive to pay out their dividends. Another risk they need to take into consideration is that their sales are projected higher than they have been in the past. To compensate for this risk while still approving the loan, they can require a higher interest rate than what it currently is. By repurchasing the stock at a low par value Jackson Automotive has the opportunity to resell stock at a greater value to raise capital. Additionally, repurchasing stock allows Jackson Automotive to retain control. Other companies are able to see the trading price, and can purchase greater and obtain control. Jackson Automotive’s financials were conservative, however, retaining control is a huge benefit. As a result of the repurchase, Jackson Automotive needed to replace their old equipment in order to meet demand and facilitate repayment of debt. Due to the need of the loans, the proposed dividend payout will not be possible. This will cause

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the cash to go into the negatives. The bank should require Jackson Automotive to hold off on their dividend payout until they are in the financial position to do so. The 1.2 million is much higher than the previous dividend payouts. Jackson Automotive would be able to pay out their dividend if they decided to pay around 10% of what they initially have proposed. This will allow room for them to still have a cash balance and helps account for the possibility of incorrect forecast of sales. Finally, for our capacity analysis, we determined to multiple all forecasted projections by 90%. We chose 90% as this was the suggested capacity in the case. Truth be told, this section gave us difficulty. After research online, we found that there are various types of capacity analysis, such as infrastructure and business process. We ultimately decided to analyze future shipments considering revenues are dependent upon those shipments. Summary: Jackson Automotive ran into financial trouble and needed not only a payment extension on their current loan, they also require an additional loan in order to purchase new equipment. Both loans would be due September 2013. Jackson Automotive has plans to also pay out dividends in September of the same year in the amount of $1.2 million. Having all of these expenditures due in September with these amounts would be impossible to maintain a positive cash balance. This would cause Jackson Automotive to run into the same issue they are currently facing; a shortage of cash. If they would like to be able to extend their current loan and have a second term loan, they must delay their dividend payment. This will allow their cash in September to maintain a positive balance, while also allowing a dividend payment in the future. If they would like to still distribute dividends in September, it would have to be an amount lower than $400,000. Given this is the forecasted amount for the month of September, they would be able to safely distribute $100,000 in dividends while still potentially having cash left over.

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