Running Head: ALLIANCE CONCRETE

ALLIANCE CONCRETE
Name of Student
Name of Course
Course Instructor
Date
 TABLE OF CONTENTS

Executive Summary.........................................................................................................................2

Introduction......................................................................................................................................3

Problem Statement...........................................................................................................................3

Analysis & Recommendations........................................................................................................4

2006 Financial Forecasts..............................................................................................................4

Invest in the Capital Expenditure.................................................................................................5

Renegotiation with the bank........................................................................................................5

Skipping the Dividend.................................................................................................................6

Conclusion.......................................................................................................................................6

Appendices......................................................................................................................................7

Exhibit 1: Financial Forecasts 2006 (with dividend payment)....................................................7

Exhibit 2 Financial Forecasts 2006 (without dividend payment)................................................8

 ALLIANCE CONCRETE
To: Martin Harris, CFO Alliance Concrete

From: Financial Analyst, XYZ

Date: 13th Feb 2017

Subject Matter: Financial Projects for 2006 & Decision for Either Dividend Payment or
CAPEX investment by renegotiating the bank loan

Executive Summary

The economy in which ready mix industry is operating is currently experiencing a

slowdown and the most notable trend in the industry was the increase in the cement costs.
Moreover, the significant growth of China has added to the worldwide demand. The rising
energy prices had also increased the cost of manufacturing the cement. Alliance Concrete was
one of the small ready mix concrete producers owned by Martin Harris. The company was
planning to generate the financial forecasts for the year 2006. Despite the recent growth and
success of the company, Harris was facing a difficult decision and he had to make a decision
from a number of options. He had to choose between postponing the long overdue capital
improvement, renegotiating the debt obligations and reducing the dividend payment to National,
the parent company of Alliance. The obligation of the company, being a ready mix concrete
company is to deliver its products to the customers on time and if the company does not invest in
CAPEX by investment in $ 2.6 million plant then the company would face long-term shutdown
and unexpected future costs. Therefore, Alliance and its management should not be negligent in
improving the performance of its plants and thus it is recommended for the company to make
investment in the new plant to improve the operational performance of the company and enhance
its reputation in the eyes of the customers.
 Introduction

Alliance Concrete was one of the small ready mix concrete producers in the Michigan’s
northern lower peninsula. The company owned a fleet of 240 mixing trucks and it operated14
mixing plants. The company has been successful because of significant income and revenue
growth over the past few years and this huge growth was driven by the strong real estate
residential market. The company continued to operate as a separate legal entity despite the fact
that it has been purchased by a Canadian construction conglomerate, National Industrial Supplies
a year before.

The CFO of the company, Martin Harris was now tasked with putting together the 2006
financial forecasts for the company and he was understandably nervous to do that for two main
reasons. First, the head office of National had made it quite clear that the accuracy of the
forecasts was a significant concern. Second, the company was looking forward to reduce the
level of the debt and pay the principle payment. However, the projects showed that despite recent
success, the investment in capital expenditure in 2006 would make it impossible to repay the
debt and pay a dividend of $ 3 million to National’s investors. Someone was bound to be
disappointed.

Problem Statement

The main problem which is now being faced by Harris is that he must choose between
postponing the long overdue capital improvements and this will prevent more costly future
repairs, renegotiate debt obligations with the bank and reducing the debt payment to the investors
of National. A slowdown of the economy and the pressure from the board of National has added
additional layers of complexity to the decision of Alliance Concrete management.

Analysis & Recommendations

First, we have generated the financial statement forecasts for the year 2006 by assuming
that Alliance will make the expected $ 3 million dividend payment to National. Then analysis of
all the three options available to Harris has been performed and recommendation has been made.
These are explained below:

2006 Financial Forecasts

The financial statements forecasts for the year 2006 have been prepared in excel
spreadsheet and these are shown in exhibit 1 in the appendices. The first financial forecast has
been prepared by assuming that Alliance would make the $ 3 million dividend payment to
National. Hence, the balance sheet has been adjusted for the bank loan and this implies a possible
renegotiation with the bank.

A number of assumptions have been made in preparing the financial forecasts which are
also stated in the excel spreadsheet. Important assumptions are as follows:

Expected sales will increases by 2.2 million yards as given in the case.
The price has been increased by 5.5% average rate of worst and best scenario.
The cost per yard has been increased by 10% to give more room to the company in case
of unexpected cost increases.
The tax rate has been calculated by taking average of the tax rates for all the previous
years.
Cash, accounts receivables, payables, accrued expenses and inventory for 2006 would be
equal to the ratio of these assets over 2005 revenues.
The capital expenditure would remain same in the dividend payment scenario but the
long-term debt would be decreased by 4 million.

After preparing the above forecast, we have also prepared another forecast for the company
in which no dividend payment has been paid to National and a capital investment has been made
in 2006. These forecasts are shown in exhibit 2 in the appendices. The analysis of each of the
options has been performed as follows:
Invest in the Capital Expenditure

Alliance is a ready mix concrete company and it has to deliver its products to the
customers on time. However, the main issue faced by the company now is its negligence to
upgrade the old plant equipment, which would cost the company around $ 2.6 million and a two
weeks shutdown. Therefore, investing in the capital expenditure to improve the operating
efficiencies is highly important for Alliance.

The company should spend $ 2 million on the expenditure before the start of the year so
that the risk of breakdown is minimized.
Since, $ 2 million would be spent before the start of the year, and then the external
financing needed would be $ 14 million as shown by the forecasts in exhibit 2.
The company can fulfill the $ 16 million obligation by borrowing $ 16 million from the
bank.

Capital improvements would save the company from long-term shutdown and the
unexpected costs. Moreover, the customers of the company are highly sensitive to the delivery
times; therefore, improving the operating capacity would save the company’s reputation and
their loyalty towards the customers. Therefore, it is recommended for the company to invest in
the capital expenditure.

Renegotiation with the bank

If Alliance, wants to finance the additional money for investing in the capital
expenditure, then the company will have to present the following forecast to the bank:

Debt to prior year EBITDA of 2.64 that could be calculated from exhibit 2.
Interest coverage of 3.01 to show that the company that the company has the ability to
pay interest on its debt.

The bank might be concerned about the recent slowdown of the economy and the real estate
market therefore, the company can put forward a number of arguments against the bank such as:
 The future sales growth would yield higher profits of the company and generate higher
profit margins.
Although the return on assets has declined in 2006 after CAPEX investment but over the
years it would increase as the company would manage its assets efficiently to generate
earnings.

Skipping the Dividend

If we want to invest in the capital expenditure, then the dividend payment of $ 3 million
will also have to be skipped. National can be convinced by putting forward these arguments:

Alliance is a financial benefit for National, therefore, it would be wise to retain the $ 3
million and invest it for capital improvement.
With this investment, Alliance would be able to do long term business efficiently.
Lastly, the company will not have to worry about the equipment breakdown and it can
avoid the unexpected costs in future.

Conclusion

Alliance Concrete’s management should not be negligent in improving the equipment of

the company. The priority of the company right now should be to improve the operational
performance and deliver high quality products to its customers without any breakdown. Also,
being a parent company, National, should not pressurize the company to pay dividend but instead
it should support Alliance and its management in funding expenditures. This is the only best
option through which Alliance Concrete can continue as a financial benefit within the portfolio
of holding of National Company.
 Appendices
Exhibit 1: Financial Forecasts 2006 (with dividend payment)

  2005   2006 Forecast

       
Yards sold (in thousands) 2,085   2,200
Average price per yard (in dollars) 89.12   94.02
Average cost per yard (in dollars) 69.35   76.28
Capital Expenditure     16,000
Depreciation     7,500
       
Income Statement ($1,000)      
Revenue 185,815   206,847
Cost of goods sold 144,594   167,826
Gross margin 41,221   39,021
General and administrative 17,327 9.32% 19,288
Earnings before interest and taxes 23,894   19,733
Interest 5,695   5,355
Taxable Income 18,199   14,378
Tax 6,210 34.81% 5,005
Net income 11,989   9,373
Dividends     3,000
Addition to Retained Earnings     6,373
       
Balance Sheet ($1,000)      
Cash 4,180 2.25% 4,653
Accounts receivable 28,203 15.18% 31,395
Inventory 4,615 2.48% 5,137
Current assets 36,998   41,186
Plant and equipment 97,476   97,476
Total Assets 134,474   138,736
       
Accounts payable 13,534 7.28% 15,066
Other accrued expenses 7,897 4.25% 8,791
Current liabilities 21,431   23,857
Long-term debt 67,000   63,000
Owners' equity 46,043   52,416
Total Liabilities & Owner's Equity 134,474   139,273
       
Financial Statement Relations      
Margins and Returns      
 Gross margin 22.18%   18.86%
Net margin 6.45%   4.53%
Return on book assets 8.92%   6.76%
Return on book equity 26.04%   17.88%
Asset Ratios      
Days receivables 55.40   55.40
Days inventory 11.65   11.17
Days payables 34.16   32.77
Total asset turnover 1.38   1.49
Fixed asset turnover 1.91   2.12
Leverage Ratios      
Debt to prior year EBITDA 2.80   2.31
Debt to total value (book) 50%   45%
Interest coverage 4.20   3.68

Exhibit 2 Financial Forecasts 2006 (without dividend payment)

  2005   No Dividends Forecast 2006

       
Yards sold (in thousands) 2,085   2,200
Average price per yard (in dollars) 89.12   94.02
Average cost per yard (in dollars) 69.35   76.28
Capital Expenditure     16,000
Depreciation     7,500
       
Income Statement ($1,000)      
Revenue 185,815   206,847
Cost of goods sold 144,594   167,826
Gross margin 41,221   39,021
General and administrative 17,327 9.32% 19,288
Earnings before interest and taxes 23,894   19,733
Interest 5,695   6,545
Taxable Income 18,199   13,554
Tax 6,210 34.81% 4,718
Net income 11,989   8,836
Dividends     0
Addition to Retained Earnings     8,836
       
Balance Sheet ($1,000)      
Cash 4,180 2.25% 4,653
Accounts receivable 28,203 15.18% 31,395
Inventory 4,615 2.48% 5,137
Current assets 36,998   41,186
Plant and equipment 97,476   105,976
Total Assets 134,474   155,736
       
Accounts payable 13,534 7.28% 15,066
Other accrued expenses 7,897 4.25% 8,791
Current liabilities 21,431   23,857
Long-term debt 67,000   77,000
Owners' equity 46,043   54,879
Total Liabilities & Owner's Equity 134,474   155,736
       
Financial Statement Relations      
Margins and Returns      
Gross margin 22.18%   18.86%
Net margin 6.45%   4.27%
Return on book assets 8.92%   5.67%
Return on book equity 26.04%   16.10%
Asset Ratios      
Days receivables 55.40   55.40
Days inventory 11.65   11.17
Days payables 34.16   32.77
Total asset turnover 1.38   1.33
Fixed asset turnover 1.91   1.95
Leverage Ratios      
Debt to prior year EBITDA 2.80   2.83
Debt to total value (book) 50%   49%
Interest coverage 4.20   3.01