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Executive Summary

Hampton Machine Tool Company (HMTC), established in 1915, caters to the military
aircraftmanufactureres and automobile manufactureres in the St. Louis area. The
companys currentsuccess can be attributed to their conservative financial policies,
making them survive thedifferent economic turmoils a couple of years ago. In
December 1978, Mr. Cowins, President of HMTC, took down a loan of $1 million from
St. Louis National Bank to purchase stocks of dissident stockholders. Now, wanting
to improve the companys performance, Mr. Cowins sent aletter to Mr. Eckwood in
September 1979, Vice President of the St. Louis Bank, asking him toextend the loan
to the end of the year and also for an additional $350,000.After conducting a
financial analysis, focusing primarily on their cash budget, it was found outthat
HMTC would not be able to fully repay their $1.35 million loan by the end of the
year. Evenif they repay portions of the loan early on to reduce their interest burden
and also stop payingdividends, they would still have problems in paying back their
loan. However, it was alsodiscovered that the company could pay back their loan on
January. As such, Mr. Eckwoodshould reject HMTCs proposal and instead propose to
extend the loan for another month butwith an interest rate increase.With a renegotiation of the loans terms, which are extending the deadline of the payment
toJanuary and increasing the interest rate to 1.75%, both HMTC and the bank will
have a better outcome. For HMTC, they would have a new equipment to help in their
operations. They wouldalso push on with their dividends and finally get rid of their
outstanding loan balance. For thebank, they would earn more interest income from
the increase in interest rate.

Case Context
Hampton Machine Tool Company (HMTC) is a machine tool manufacturing business
whichstarted in 1915 and has been a stable company since its establishment. The
companysrevenues rely heavily on military aircraft and automobile manufacturers
within the St. Louisvicinity.During 1960s until end of 1970s, HMTC experienced
highs and lows which were mainly due toincreases and decreases in production.
This is influenced by the Vietnam war, economicconditions, expansion of export
market and demise of competitors. Though adversecircumstances happened, HMTC
has successfully survived these problems. This can beattributed to the companys
conservative financial policies.In December 1978, Benjamin Cowins, President of
HMTC, requested a 1M USD loan to St.Louis National Bank to purchase stocks of
several dissident shareholders. The interest rate for the loan was 1.5% to be paid
monthly and the principal of the loan is to be paid on September 1979. Mr. Jerry
Eckwood, Vice President of St. Louis National Bank allowed the loan requestbecause
of three reasons: 1) HMTCs submission of projected sales and forecasted
financialstatements; 2) HMTCs credibility as depositor in St. Louis Bank and 3) Mr.
Cowins credibility inthe business community. However, in September 1979, Mr.

Eckwood received a letter fromHMTC requesting to extend repayment of the loan to

December 1979 and a further loan requestof 350,000USD for equipment purchases.
Point of View and Problem Definition
The point of view to be taken in this case will be as Jerry Eckwood, a creditor. As a
creditor,aside from the financial ratios, one of the most important things to be
looked at for a possibleborrower is whether they could repay their loan upon the
date of the loans maturity. As such,the main problem for this case is: Should Mr.
Eckwood accept Mr. Cowins proposal regardingthe extension of the original loan
and an additional $350,000 loan?
The group will take a creditors point of view for this case. As such, the important
things to belooked at are the financial ratios and, more importantly, their cash
budget. By looking at their cash budget, the group would be able to find out if they
could pay their debt in their proposedtarget date.
Profitability Ratios
Liquidity and Leverage Ratios
Cash Budget

AnalysisFinancial Ratios
To analyze the financial viability of the company, we used financial ratio analysis to
evaluateHMTCs profitability, operating efficiency, liquidity and leverage. (See
Exhibit A for the financialratios of HMTC).
HMTCs profitability ratios, generally, has an unstable trend. Though, most of these
ratios areseen to be improving over time especially the projected ones. There is a
significant increase inHMTCs operating profit margin and gross profit margin from
historical trend to its projectedusing the projected financial statements. As seen in
the ratios, its gross profit margin is highexcept for September. The main reason for
this is because of the WIP inventory reduction of $1320 in September. Because of
this huge reduction in WIP, operating profit margin for September is -13%, signifying
that HMTC would be operating at a loss.However, it would be good to note that after

this reduction in WIP, profitability ratios for thecompany would be seen to be

increasing. With COGS and Operating Expenses would beforecasted to be relatively
stable from October to December and Sales to be increasing over theperiod, the
profitability ratios would naturally show that HMTC would be profitable for the
threemonths after September. With this, it can be seen that the company is
profitable, making themworthy of extending credit to.
Liquidity and Leverage
The result of the companys liquidity and leverage ratios based on the projected
financialstatements shows an improving set of ratios. HMTCs quick ratio is less than
1 and has beenconsistently below 1. Its current ratio trend plays around 1 to 2,
which is not acceptable for anindustrial machinery company since this only applies
to companies which have inventories thatcan immediately be converted into cash.
Furthermore, an average of quick ratio less than 1connotes that the liabilities end
up being greater than the companys assets and thus there is agreat reliance on
inventories to cover for immediate payment obligations.HMTCs total assets are
financed by debt with an average of 56% during June to August but,declined to 46%
using its projected ratios. On the other hand, the companys debt-equity ratiohas an
average of 0.97. For a company with a capital-intensive nature, it is acceptable to
have adebt-equity ratio and total liabilities-total assets ratio of above 1 but this
implies that most of HMTCs company's assets are financed through debt and thus,
the company has a greattendency to aggressively finance its operations and growth
with more debt.

Current Cash Budget

Seeing, however, that the companys cash budget could be computed, it would be
better tofocus on this instead of on their ratios. Looking at Exhibit B, it can be
noticed that the problemdoes not have any liquidity problems stemming from their
usual operations. Their cash coulddefinitely cover their cash disbursements for
operations even though there would be times whentheir cash receipts are low. The
following assumptions were used in coming up with the cashbudget:a)100% of the
previous months Accounts Receivable will be collected given the 30 dayscredit
Purchases are paid a month after.c)Tax payments will be done on September and
Other Operating Expenses will remain stable for the period and are paid the month
itself.As seen in Exhibit B, HMTC would perform quite well once they get their

equipment to improvetheir operations. Their ending cash balances reflect that they
dont need additional borrowingsto fund their operating activities. However, the only
problem HMTC would experience is their repayment of the loan. If they go through
with their current cash budget, they will actually needextra funds to cover a
negative cash balance of $331,500 due to the loan payment. Actually,even if HMTC
restructures their loan by paying ahead of time to decrease the interest burdenand
also postpone paying dividends (see Exhibit C), HMTC would still have a negative
cashbalance of $163,500 by December. This shows that HMTC still cant pay their
outstanding debton December even if they tinker with their figures.However, still
looking at their current cash budget in Exhibit B, one would notice that HMTCwould
have a cash balance of $933, 500 on January. This is due to the collection of their
accounts receivable coming from December sales. As such, the company, instead of
asking for an extension of up to December, should have asked for an extension up
to January. HMTCseemingly forgot that, even with their good forecast figures, they
have to also check when theyexpect to collect their sales. In this case, it seems as if
they neglected to factor in that they couldonly collect their sales fully the next
month. As such, by extending the payment of the loan toJanuary instead of to
December, HMTC would be in a much better position to fulfill their proposal to pay
their outstanding loan of $1.35 million.
Decision and Justification
The decision, after analyzing the companys performance, especially their current
cash budget,would be to reject their proposal. As a creditor, whose main concern is
the borrowersrepayment of the loan along with the required monthly interest
payments to it, it would be easyto see that HMTC would not be able to repay in full
their outstanding loan on December. Even by postponing its payment of dividends
and repaying part of their loan early on to reduce their interest burden, HMTC would
still not be able to pay in full their $1.35 million loan by the end of the year.From the
analysis done, however, it was seen that HMTC could repay their outstanding loan
onJanuary the next year. It would be better, then, for the bank and also for HMTC if
the repaymentcould be extended for one more month. As such, terms regarding the
loan should berenegotiated.
Operationalize the Decision
Of course, renegotiating the loan repayment should have a penalty attached to it.
The penaltywill come in the form an increase on the interest rate on the loan HMTC
would be facing. Byraising the interest rate from 1.5% (18% per annum) to 1.75%
(21% per annum), the bank wouldbe gaining more interest income from HMTCs
loan (see Exhibit D). As such, the extension of the loan would be good for both
parties. For HMTC, they could still distribute dividends onDecember since they
would have cash on hand. Also, though they would be faced with moreinterest
expense, they could still incur this increase as the increase in interest expense
wouldnot dent their financials too much. They could also finally settle their

outstanding loan and haveit finally removed from their liabilities.For the bank, apart
from the increase in interest income of $26,625 coming from the renewedterms on
HMTCs loan, their working relation with HMTC would improve. HMTC would
mostlikely acknowledge the banks continued assistance to them by accomodating
them through thecompanys tough times. However, as seen with the decision,
penalties would arise if HMTCwould fail to meet their obligations with the bank.
Operating Efficiency
- Could we remove this since we will be assuming naman their operationsto be fixed
to arrive at our forecasts?Comparing the historical data to its projected ratios, HMTC
is expecting to have higher turnovers of its accounts receivables and inventories.
From June to August, the companysaccounts receivable were decreasing in dollar;
this decline goes hand-in-hand with thecompanys dropping net sales. In
September, HMTCs projected a grand $2163 from itsprevious years sales of $507
that is equivalent to a 327% increase. This led to an increasingaccounts receivable
turnover ratio from August to September.On the other hand, the velocity of
conversion of HMTCs inventories into sales is relatively slowif we will compare the
companys net sales and inventories. Over the years, the companysinventories
have been increasing its share to its total assets. With such high inventory, it is

unlikely to sell everything in less than a year to pay off its current obligations on
time and canresult to even greater losses. How can you say this if we will assume
that we will collect all ARin 30 days?