04 - Hampton

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University of California, Los Angeles *

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231E

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Finance

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Nov 24, 2024

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Hampton Machine Tool Company: Case Discussion S.W.O.T. Analysis: STRENGTHS:  Conservative company w/high working capital and low levels of debt.  Mr. Cowins was a highly respected executive.  Sector improving in the last period.  Gain market share due to lower number of competitors  For first time since 1972 it expects to operate at full capacity  Backlog of orders 90% of capacity  High cash balances at the bank made them a favorable company to deal with! WEAKNESSES  Too dependent on economic downturns. Beta>1.  Cyclical business  Experiencing supply problems  Debt is very costly (18%) OPPORTUNITIES  W/new investment the company would reduce the backlogs.  They are able to produce immediately  Can change his capital structure and take on more leverage and get tax shield  THREATS  Backlog orders can be canceled.  The delay in receiving supplies can affect Hampton service and reduce sales.  It can have a shortage of cash to repay debts  Debt is about to mature and he can’t finance it. Problems: Extending or not the current $1MM loan to $1..35MM. Also, extending the terms, from September to December. Alternative financing methods:  Ask for long term debt. Hampton is financing long term needs (equity and fixed assets) w/short term debt.  The projections do not consider minimum cash balances. In any of the two cases it will not be possible to repay the debt. It should be better to extend terms. Improvements: - Improve timing with some suppliers 1) Why can't Hampton repay its loan?  Sales have fallen short of projections by 27% from projections 8.688A/11.919E = 73%  Financing long-term needs with short-term debt – though it was anticipated to be a short term activity  Why does it need more bank financing?

 At the same time as he was projecting sales increase, he was producing at capacity, and wanted to improve the facility and upgrade the equipment – that is why he needed the $$.  He was using the loan as a bridge over a short period of time – it is a timing issue  It is one big timing issue coupled with the fact that sales are down.  Timing problem of more than 86 days of receivables and 28 days payable 2) Prepare a projected cash budget for the 4 months (9/79-12/79). Prepare a projected income statement for the same period. Prepare a proforma balance sheet as of 12/31/79. Review your results. Do the cash budgets and proforma statements yield the same result? Why? No they don’t: One is accrual and one is cash. He has less sales He has this cash advancement to see what the cash inflows are The problem will be the $400 expenses that are not included in the raw materials or interest. Under our estimates the actual expenses are: September October November December 814 440 469 843 Actual Expenses 3) Evaluate the assumptions on which your forecast are based. Sales comes from company projections on shipments COGS/Sales = 64% Admin exp = 11% EBIT = 23% All projected over sales Taxes = 48% Interest rate = 1.5% per month Collection = 30 days Payables = 30 days Labor 29% of COGS (based on June figures) Excess inventory is liquidated in September and October results in a net cash from labor of $396 – which is more We don’t get anymore advance payments Minimum cash balance of $300 What developments could alter your results? Can Hampton repay the loan? If Eckwood dies, there could be management issues Sales projections for final 4 months are still aggressive, and if they don’t occur there will be a major change in the businesses ability to continue 4) Should Eckwood honor Cowin's loan request? What are the risks? What are Eckwood's alternatives?

Profitability is strong Current ratio is ok, but not great (bet 1 & 2) Leverage is ok as well Interest coverage is ??? EBIT / SALES = 22% Financing a long term debt with a short term loan. Had he been able to pay it off in the long term, he would not have had to borrow more. The risks are that this is not just a seasonal issue, but a permanent business problem. Restructure the loan to be a long-term loan, or make it a line of credit.

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