Kimball International - Page 119

Solution to Kimball - Credit standards and credit period decision.

Here is some additional information you may wish to make available to students: Web sites (current as of 10/10/2001) Content http://www.kimball.com/discoverkimball/index.cfm?strPage=dsp Overview Kimball history http://www.kimball.com/index.cfm?strPage=mnuBusUnits Kimball companies and products http://www.lodging.kimball.com/ Lodging Group info (more below) Mailing address Phone: 800-451-8090 Kimball Lodging Group ( 7:45-4:30 Central Time) 1180 E. 16th Street Jasper, IN 47549-1001 Kimball Lodging Group provides standard product lines of furnishings for all areas of hotel and motel facilities: guest rooms, lobbies, lounges and restaurants. Also, the Group offers high quality, custom-designed furniture for prestige hotels, resorts and hospitality chains worldwide. Additional offerings include an extensive line of specialized furnishing for the healthcare market's long-term-care facilities. Working with other Kimball units, the Kimball Lodging Group provides total facility furnishings for all operational and office areas. ASSUMPTIONS (for Lodging Group) Cash and marketable securities $139,250,000 (25% of TA) WACC (% per year) 10.00% ST Investment Rate (% per year) 6.50% Present credit period 45 days Average credit period 54 days Bad debt losses (%) 1.70% Sales $85,000,000 VCR 45.00% Tabular data from case: Expected Sales ($ mils.) 85 Customers' Sales Collection Collection Period 54 66 63 70 Bad Debt Rate (% of Revenue) 1.70% 2.00% 2.30% 2.45% Credit Admin. & Collection Exp. (% of Rev.) 1.00% 1.10% 2.00% 3.00%

POLICY Present Proposal A: Lengthen CP 95 Proposal B: Ease Standards 100 Proposal C: Both A & B 105

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Calculations and Recommendations a.) What proposal, if any, should be adopted based on the value effect? Why did you choose the discount rate you used? First, compute daily sales to get one day's sales: Present $232,876.71 Proposal A $260,273.97 Proposal B $273,972.60 Proposal C $287,671.23 Second, apply Daily NPV formula to the present situation and each proposal: For the existing policy ("Present"), we have:
ZE = S E (1 d E ) p E (1 bE ) S E (1 p E )(1 bE ) EXP E + VCR ( S E ) (1 + iDPE ) (1 + iCPE ) (1 + iCPE )

Present policy:

PV of SE $225,580.45

VCR(SE) $104,794.52

PV of EXPE $2,294.82

ZE $118,491.12

On a cashflow timeline, we can see this better: Day 0 Day 54 ---|-------------------------------------------------------------|----------------------->sales / day * VCR= $232,876.71 sales per day 232876.71*45% -$3,958.90 bad debts -$104,794.52 -$2,328.77 EXP =variable costs $226,589.04 total | $223,285.64 | =PV of Day 54 cash collections discounted by simple interest $118,491.12 =NPV of cash collections - variable costs = ZE For a new policy (Proposals A,B,C):
1iCP N EXP N [ 1 g S E ] VCR [ 1 g S E ] 1iCP N Z N=

[ 1 g S E ] 1d N p N 1b N [ 1 g S E ] 1 p N 1b N
1iDP N

We don't have to compute (1+g)SE because the proposals all have sales estimates attached. Also, there is no cash discount, so the first term drops off. We then determine the NPV of a switch from Present to Proposal with the NPV formula:
NPV = = Z N Z E Z

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Substituting, here are the Z's for each proposal: Proposal A PV of Sales $250,538.21 VCR(Sales) $117,123.29 PV of EXP $2,812.16 Day 66 ZN $130,602.76

Details are shown on the timeline below. Day 0

---|-------------------------------------------------------|----------------------------> sales / day * VCR = $260,273.97*45% = -$117,123.29 $260,273.97 sales per day

-$5,205.48 bad debts -$2,863.01 EXP $252,205.48 total | $247,726.05 | =PV of Day 66 cash collections discounted by simple interest $130,602.76 =NPV of cash collections - variable costs = ZN Proposal B PV of Sales $263,129.54 VCR(Sales) $123,287.67 PV of EXP $5,386.48 ZN $134,455.39

Details are shown on the timeline below. Day 0 Day 63 ---|-------------------------------------------------------------|------------------------> sales / day * VCR = $273,972.60 sales per day $273,972.60*45% = -$6,301.37 bad debts -$123,287.67 -$5,479.45 EXP $262,191.78 total | $257,743.06 | =PV of Day 63 cash collections discounted by simple interest $134,455.39 =NPV of cash collections - variable costs = ZN Proposal C PV of Sales $275,342.74 VCR(Sales) $129,452.05 PV of EXP ZN $8,467.74 $137,422.95

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Details are shown on the timeline below. Day 0 Day 70 ---|------------------------------------------------------------|-------------------------> sales / day * VCR = $287,671.23 sales per day $273,972.60*45% = -$7,047.95 bad debts -$129,452.05 -$8,630.14 EXP $271,993.15 total | $266,875.00 | =PV of Day 63 cash collections discounted by simple interest $137,422.95 =NPV of cash collections - variable costs = ZN Comment: in the base case we go with the WACC as the appropriate discount rate, given the expectation that the decision is a multiyear one, making this a longlife capital project competing with other capital projects. If one perceives a shorter timespan, a strong case may be made for using the ST investment rate as the appropriate opportunity rate. See the "ST Invest. Rate" tab in the spreadsheet solution ("Kimball.xls") for a redo of the analysis using the ST investment rate. The results are not materially different (C is still best), although the project NPVs would clearly be different for a perpetuity PV calculation.
NPV = Z i

Delta Z = $18,931.83 Delta NPV = $69,101,174.41 b.) Does the company's financial position strengthen or weaken the recommendation in part (a) ? Strengthens it--no case can be made for capital rationing here. Further, the rate earned on short-term investments is low (6.5%) relative to any of the proposals, which are earning more than the WACC of 10%. c.) Capital allocation to another (Electronic Products) division instead of the Lodging Group? This question is motivated by a desire to integrate STFM with capital budgeting practices throughout the company. Ideally, if that division has good projects, they should be funded--Kimball has surplus liquidity (and has had surplus for several years). But do invest in this project as well.

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d.)

Likely competitor reactions to unilateral Kimball action(s)? How would one incorporate this into the present analysis? Unless Kimball is seen as no competitive threat at all to a dominant player in the lodging furniture industry, there will be a matching of the change in all likelihood. A revised sales effect would have to be made, possibly the downward price pressure would also result in a higher VCR (and possibly higher EXP) as gross margins decline relative to the original analysis.