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Yang Pu Case: Clarkson Section: 3

1. Identify the key problem in the case and explaining why it is the key problem. The key problem of the Clarkson Lumber Company is the shortage of cash. The company has been expanding rapidly for several years. Increases in working capital requirements have outgrown the capacity of the firm to generate funds from internal sources. Also, part of the funds was used to buy out a partner, further increasing financial pressure. The firm has foregone taking discounts on accounts payable and is borrowing increasing amounts from the bank so as to maintain its expansion. Mr. Clarksons decision today is whether to expand and, if so, how to raise new funds. He is seeking a new bank connection from which he can borrow larger amounts. In turn, the bank must estimate the amount of funds actually needed by Mr. Clarkson, the probable repayment schedule, the nature and degree of the risks incurred and the appropriate terms of such a bank loan. 2. Why has Clarkson Lumber borrowed increasing amounts despite its consistent profitability? Mr. Clarkson wanting to increase the amount of borrowing that would be needed to continue with his operations. One of the reasons is that he wants to pay off Mr. Holtz in order for himself to become the primary owner of the company. Another reason for the need to borrow funds is that the net income was growing at a slower rate than the operating expenses. Between the years of 1993-1995 the net income only rose from 60k, 68k ,77k thousand respectively. The operating costs for the 3 years rose from 622k, 717k, 940k thousand respectively. Mr. Clarkson needs to take out a loan so he could increase the purchasing power for goods. This would be accomplished by Mr. Clarkson having liquid cash to use for prompt payment, which will lead to acquiring trade discounts and then Mr. Clarkson will have a competitive advantage in terms of buying power. 3. How has Mr. Clarkson met the financing needs of the company during the period 1993 through 1995? Has the financial strength of Clarkson Lumber improved or deteriorated? The financing needs of the past have been met by taking a term loan of $399,000 that was fixed by the assets the company had. Mr. Clarkson had control liabilities that were offset by the increase in sales. It is deteriorated. The liquidity in the company has kept decreased over the 3 years. 1993- 1996. Current ratio has gone down from 2.4945 to 1.1480, Quick Ratio down from 1.2691 to 0.6085, Cash Ratio down to 0.1564 to 0.0515. 4. How attractive is it to take the trade discounts?

Trade discounts are definitely a very lucrative option. Clarkson Lumber can get a discount of 2% on a payment made within 10 days, which means that they will have to pay $98 instead of paying $100 in 30 days. Also from our projections for 1996 we can see that if Clarkson Lumber avails all the available purchase discounts that they could save a total of $69,000 which is a substantial amount considering that without these trade discounts their net income would be just $82,000 and will have an overall impact of $42,000 on their balance sheet 5. Do you agree with Mr. Clarksons estimate of the companys loan requirements? How much will he need to finance the expected expansion in sales to $5.5 million in 1996, and to take all trade discounts? Based on the pro forma balance sheet and the pro forma income statement, Mr. Clarkson would need $750,000loan. This would be justified in terms of using the following formulas, which is derived from the 1996 Pro Forma Balance Sheet (figures are in thousands): Total Assets Total Liabilities Net Worth 2179 - 533 1395 = 251Following the 251 that would be needed to aide in reaching the goal of $5.5 million is $399,000 thousand to pay off the loan to Suburban Bank, which would bring the total needed to $650,000. Finally, Mr. Clarkson would be able to take out the remaining $100,000that he needs to pay off Mr. Holtz, which brings the total to $750,000. 6. As Mr. Clarksons financial adviser, would you urge him to go ahead with, or to reconsider, his anticipated expansion and his plans for additional debt financing? Mr. Clarkson should first consider the possibility to change. It appears that the rapid expansion did not have phenomenal improvement in net profit and will make the company in dangerous spot in terms of debt perspective. The companys asset management and operation deteriorated over time. Mr. Clarkson should emphasize the high-profit outlets enhance corporate governance to achieve a decent profit.

7. What do you think Mr. Dodge should do and why do you think so. If you were the banker, would you approve Mr. Clarksons loan request, and if so, what conditions would you put on the loan? Mr. Dodge should make a long-term loan to Mr. Clarkson. As a banker I would like to see both the Pro Forma Balance and Income statements for the Clarkson Lumber Company before any loan decision would be made. The company also has a good strategy in terms of competing with outlet stores because of having more inventories in stock and allowing the customers more time to pay for their purchases. Another positive aspect to Clarksons Lumber is that it has good references, which show that business relationships have been stable and should continue. There is a good buffer of protection if the housing market takes a downturn. The company has a high percentage of business from repairs, which helps the balance of income.

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