Cape Chemicals wishes to increase their operations by adding new product lines.

However, in order to do so, they must make capital expenditures totaling $4.2 million.
Unfortunately, banks will not give them a loan due to a high Times Interest Earned ratio; it
currently measures at 1.81 and needs to be below 50% in order to qualify for a loan. If they
don’t issue bonds, they will not be able to raise the funds necessary to proceed with the
planned project. They are earning borderline profits due to the type of business they are in.
They prefer to not issue stock to prevent diluting ownership.
First of all, the inventory is too high. The costs associated with the increasing inventory
are affecting the free cash flow and debt of the company. Currently, the variables costs stand at
.89 which leads to debt disappearing by year 2010. If the costs of the inventory were to
increase, V value at .9, it would take another year to eliminate debt. However, if the costs of
maintaining the inventory were to decrease, V value of .80, the debt would disappear by 2009
and the CATO would increase greatly, enabling the company to invest with funds at its disposal
instead of worrying about qualifying for loans.
V=
0.888
0.9
0.804

V=
0.888
0.9
0.804

Cato
2008
$4,826
$4,215
$9,082

2009
$1,865
$1,276
$5,973

2010
$2,040
$1,396
$6,530

(realistic)
2011
$2,269
$1,561
$7,208

Debt
(realistic)
2008
2009
2010
2011
$4,295 $1,544 ($1,382) ($4,537)
$4,906 $2,744
$463
($1,983)
$39
($6,820) ($14,235) ($22,329)

The lower the working capital, the more free cash flow is available and the lower the
debt. Once again, this is affected by the inventory levels; by lowering these, we can lower the
overall W value. Also, there was mention that the company is practicing a “soft approach” to
collecting; this also contributes to the W value. Increasing sales is a good thing; however, not
getting paid is having a detrimental effect on the company as cash on hand decreases when
payments are made to the payables. Lowering the credit standards also harms the W-value.
While the effects may not seem too drastic, the values used were really conservative, but you
can still see that the lower W-value yields better end results.

W=
0.152
0.169
0.134

Cato
(realistic)
2008
2009
2010
2011
4825.673 1865.438 2040.268 2269.478
4960.341 1837.831 1997.292 2208.728
4689.665 1893.319 2083.672 2330.832

The target sales of $7.8 million is unrealistic and not within control. A more realistic
forecast would be 6.7 million as a best scenario. This is based off of the current economy not
doing so great. This may equate to a loss in business as our customers may also take a hit from
the market. Debt would be eliminated in 2011, with current market conditions, or 2010 with a
favorable market and a realistic growth rate.
Target Sales of 7.8 Million
year
2008
2009
Cato 4825.67 2577.01
Sales 78000
70200
Debt
4,295
832

Realistic outlook
year
2008
Cato
3883.9
Sales 67298.7
Debt

5,237

2010
2011
1923.25 1982.25
68094 70136.82
-1,976
-4,844

2009
2010
2011
1765.53 1176.23 1200.18
60568.83 58751.77 60514.32
2,586

524

-1,562

Perhaps we should consider holding off a bit before jumping into the proposed project.
If we hold off on expanding inventory, buying property and equipment we could attempt to
adjust our V, better results may be reached. Below are two tables comparing the debt and
CATO between making the capital expenditures or holding off and adjusting the V-value.
Holding off on pursuing the project leads to elimination of debt within the 2nd year. It also yields
a more favorable CATO

1.2 M DEBT
No CE DEBT;
V=.8

2008
6,695

2009
4,320

2010
1,878

2011
-672

1,986

-4,708

-11,871

-19,613

1.2 M CATO
No CE CATO;
V= .8

2008
2426

2009
1489

2010
1557

2011
1664

7135

5808

6278

6857

If we do decide to pursue this project, we would have to definitely issue stock in order to raise
the funds. Stewart is against issuing stock, so perhaps issuing bonds would be more ideal. Alternatively,
we could use the increased cash flow from lowering working capital or variable costs to lower our debt.
This would lead to decreasing our TIE ratio and let us qualify for loans in the future. Another solution
would be issuing bonds to raise capital and prevent diluting ownership. However, the financial ratios
aren’t the greatest; leverage is a bit high and profit margin percentage is really low.
The recommendations I have are to eliminate current debt by way of decreasing variable costs
and current and future working capital. This would enable us to apply for loans in the future. To raise
funds for our current project, issuing bonds would be the best method; it would not affect company
ownership. Also, I would recommend reverting to a proper collection period for receivables. This would
provide a higher CATO figure, which would appeal more to potential bond holders, providing more
capital to pursue additional projects or expand operations.