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Butler Lumber Company Case Report

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Report of Case #A: Butler Lumber Company

Group Members: JIN Jian, YANG Sixuan, HUANG Yan, XIE Yu

Q1:

The Butler Lumber Company gained its advantage on price competition by careful control of operating expenses and by quantity purchases of materials at substantial discounts (2/10, n/30). The discount of 2% in materials can only be achieved by conducting the cash payment within 10 days. An estimation on the interest expenses versus discount savings was conducted in the attached list (calculation 1), reviewing that the interests were worthy spending as the company can reduce the total expenses in this way. However, in 1989 and 1990, the company got few discount purchases due to cash shortage and the accounts payable increased according to the balance sheet (chart …). Thus, sufficient cash reserves are required to support the business.

As one of the major methods to make the business profitable, early payments required a sufficient cash reserves in Butler Lumber Company. Additionally, Mr. Butler anticipated a sizable expansion of the business in the following years and needed additional loan to support the daily operation by increasing the working capital to associate with the expected sales volume and also to conduct further relevant fixed asset investments.

For the expansion expected by Mr. Butler, which is 3.6 million in 1991, we also calculate whether external financing is needed according to the internal growth rate in sales. The idea is to find out when no external financing was provided and the company solely rely on the internal source of capital growth to associate with the sales expansion volume, what is the maximum growth rate in sales that can achieve. The calculation was listed in the attached form (calculation 2). The expected sales growth (…) is more than the maximum growth rate (…) that the internal source can provide. For the above reasons, additional financing was needed to help Mr. Butler run the business.

Q2:

Assuming the same efficiency in 1990 and targeting sales volume as 3.6million, we forecasted cash needs in the year 1991. We agreed on the Mr. Butler’s estimation that the $247,000-loan offered by Suburban National Bank was not sufficient to support the targeted growth in sales and a maximum $465,000-loan offered by Northrop National Bank, though the size surpassed foreseeable needs, would provide more flexibility on the financial management1.  

The estimation has been made on the precondition that the operating efficiency (concerning assets turnover ratio, ROA, etc. are same as those in 1990), together with the expected sales growth, estimation of some payable accounts, the Notes payable from bank is estimated at an amount of $432,500.

Q3:

As Mr. Butler’s financial advisor, I won’t agree with the expansion and additional debt financing.

Expansion:

The company’s self-sustainable growth rate (SGR) is 15.60%. Assuming that operating efficiency remains the same as 1990 and equity financing doesn’t happen, SGR represents the company’s highest growth rate. But the expected sales increase rate of 1991 is 33.63%, much higher than SGR, which indicates that the estimate net sales of 3,600,000 is unreasonable. Therefore, Butler should decrease the estimate net sales. If Butler wants to keep the net sales on such a high level, he needs to increase operating efficiency or use more equity-financing tools instead of debt-financing.  

Debt financing:

Firstly, the company’s debt-paying ability is very weak. The total debt ratio, debt-equity ratio and times interest earned keep increasing and are on relatively high level, which means the company has a high leverage. Secondly, because we are discussing a 90-day loan, the liquidity ratios are more important. In general, cash ratio should be more than 0.2, quick ratio should be 1, current ratio should be 2. However, the company’s liquidity ratios are all below the normal level and have a trend of declining. Therefore, the company is too risky to pay the loan.

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