Lecture3 - clarkson lumber

24 financing needs ability to pay

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Unformatted text preview: t of Clarkson’s trade credit? Is it really more costly than bank financing? Clarkson’s suppliers typically offer a 2% discount for payment within 10 days, but currently, Clarkson is stretching payments to about 40 days in 1995. So the actual terms of credit are 2/10 net 40 23 Cost of Payables Financing With terms 2/10 net 40 days, you pay 98% of the invoice if you pay at day 10, but you incur an additional 2% of the invoice by delaying payment from another 30 days. So the interest rate for 30 days is 2/98 = 2.04% To convert it into annual rates, calculate EAR = [1 + 2.04%]365/30 – 1 = 27.9% Compared to the 11% rate that seems to be generally applicable to bank financing, this seems quite expensive. 24 Financing Needs & Ability to Pay Would a credit line of $750,000 meet Mr. Clarkson’s needs over the next year, as he anticipates? Think about why the bank would want to know this: – What if the $750,000 overstate the firm’s needs? – What if the $750,000 understate the firm’s needs? Our focus here: Assuming that Clarkson carries his proposed strategy and that the bank provides any necessary financing, how much money will the firm need? Then we will compare our own estimate of the amount Clarkson would need with the amount he requests. This will tell use whether his financial plan is consistent or not. 25 Pro-Forma BS & IS Our pro­forma analysis will estimate Clarkson’s financial requirements, but more generally you could use it for any other purposes of your interest Since we want to estimate financing needs, the “notes payable to the bank” item of the balance sheet as of December 1996 will be our “plug” number. Assumptions for 1996 – Sales volume will be $5.5 million – The $750,000 loan is granted and new payables policy is implemented at the beginning of the year – Thus, all purchase discounts taken during the year – Other historical relations for 1993­1995 hold for 1996 26 Pro-forma Income Statement for 1996 Sales 5,500 1 587 2 4,234 5 Cost of Goods Sold Beginning inventory (Dec. 95) Purchases 1 4,821 Ending Inven...
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