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Hampton Machine Tool Company

Hampton Machine Tool Company Homework Case #1 Crystal Brinson FINC 430 Section: 6980 Professor S. Parshley June 17, 2008

Introduction: Hampton Machine Tool Company is a machine tool manufacturer, which was founded in 1915. Their primary customer base is military aircraft manufactures and automobile manufactures in the St. Louis area. Hampton was very profitable in the 1960s due to Vietnam War needs, but profitability slowed down in the 1970s with the USs withdrawal from Vietnam War and the oil embargo. After they managed to stabilize and by the late 1970s clutched a larger market share due to competitors that were unable to make it through these difficult times. They had no debt for the 10 years prior to December 1978, that month they took out a $1 million loan from the St. Louis National Bank. The loans terms were monthly interest payment at a rate of 1.5% with the principle to be paid back at the end of September 1979. Now in September of 1979, Hampton has asked for an extension on this loan to the end December 1979. Hampton also has asked for an additional loan of $350,000 with promise of repayment at the end of December 1979 and interest payments monthly at the rate of 1.5%. This additional loan Hampton sees as a necessity for the update of their machinery which hasnt been done since the economy went into a recession in the early 70s. Analysis: Hampton Machine Tool Companys current financial problem is the ability to payback its existing loan and the request for a new loan from the St. Louis National Bank. By following their current plan Hampton will be short $331,000 (Exhibit 2) in December. This profitable firm has fallen behind on their orders and Mr Cowins suggests that they need more financing to purchase needed equipment. They have informed their bank that they will not be able repay in September and have requested an extension. Hampton has been operating at full capacity and with additional back orders, which has put their shipment of orders behind. They have also run into upset in the shipment schedule

because they have been waiting for parts from their suppliers. The falling behind has also caused them to have less than whats needed for accounts receivables turnover. Unfortunately the cash budgets and pro forma financial statements yield negative results regarding the principal payment of the loan for December (exhibit 2), based on current plans. The forecasts in this analysis are based on projected sales, one month extension of the loan and dividend payment, as well as starting to repay the loan early. Subsequently, if sales projections and accounts receivables are not met (30 days net) then this could alter the results drastically by putting the company in more of a financial bind. From my forecasts it seems that Mr. Cowins is incorrect about being able to repay the loan in December, but should be able to repay in January with more accurate planning. Hampton repurchased a substantial fraction of its outstanding common stock, because it had decrease sufficiently in value. Despite their good intentions to increase their stock value their finances have suffered because of the repurchase, which included taking out the original loan of $1 million. Mr. Cowins proposal to pay dividends in December is not reasonable, because the companys finances will suffer (exhibit 2) causing them to have negative cash flow. Solution: Unfortunately they cannot afford to repay the loan in December; if they proceed with their original plans they will have negative cash flow (exhibit 2) in December. They should request a one month extension on the loan and to show good faith then ought to start repaying it early. They should start the repayment process in September with $200,000, another in October of $100,000 (shown in exhibit 3). They cannot afford to make a loan payment in November, but will be able to repay $350,000 in December. These early payments decrease the interest and the final loan payment making it easier to settle up the loan. Regarding the full loan repayment by December the extension of one month until January will enable them to make a final payment of $700,000 ($350 left

from the original loan & $350 full payment of the second loan) once December accounts receivables are collected. Hampton cannot afford to make a dividend payment in December, despite their willingness of doing so. Holding the dividend payment until January will free up $150,000 in December keeping net cash flow in the positive (exhibit 3) and allows for December sales (30 days net) to be realized, therefore usable to make the January final payment. This enables the company to remain profitable for the future and in turn the stock will not become valueless. In order to show appreciation to their shareholders they can increase the dividends to $200,000 in January if they chose which is whats proposed in exhibit 3. Justification:

Extending the loan repayment one month until January allows for accounts receivables of December to become collected, because of their collection policy of 30 days net. Also this means Hampton will not have to go into the negative to pay the loan in December keeping cash flows at a positive, expectable level.

Starting repayment early in September allows Januarys principal payment amount to be lowered (more manageable) as well as lowering interest payments and saving cash.

Holding the dividend payment until January frees up cash in December to help compensate for the $350 loan payment. This also helps keep the net cash flow positive in December and as well as waiting for accounts receivables of $2,265,000 to come in January.

Increasing dividends payment to $200,000 satisfies shareholders and is increased to thank them for their patience, because they are not receiving dividends as initially intended in the month of December. Summary:

Mr. Crowin should go forth with the proposed solutions as mentioned to make his company more profitable after January. Also this would strengthen his relationship with the bank, by paying off both loans. This plan is also very generous to the shareholders. Mr. Eckwood with St. Louis National Bank should reject the $350,000 loan request based on the current terms proposed by Hampton Machine Tool Company and based on the forecasted pro forma statement/cash budget. The forecasts presented in exhibits 1 & 2 shows an inability to repay the 1st loan. The numbers fall short of being able to repay the original loan in December without even considering the requested loan, but with the proper financial adjustments both loans (the original of $1 million and requested $350) can be fully repaid by January. However the bank may want to grant the loan anyway for relationship reasons, as long as the terms are reworked to help assure they will get paid. Reworking by the extension of the loan, early payments, and delayed dividends will leave Hampton in a manageable situation allowing them to continue to be a profitable customer of the bank. Mr. Eckwood should bring up the previously mentioned solutions in Exhibit 3, but the bank will want to make sure they put Hampton on a repayment plan so in the near future they can expect to collect the principal of the outstanding loans.