Project description Treat the case as a business case with a finance emphasis. Write from the perspective of a consultant to the firm’s management, advising how to optimize the owners’ wealth. The marketing, operations and other management aspects are important. About half the grade is on the qualitative analysis. Always approach the case from the perspective of a financial management perspective, despite some cases seeming to emphasize a financial institution’s perspective. Strong Tie Ltd ¢Do cash flow forecasts for 2009-2012 ¢Inflation rate = 0.02 ¢Note the restatement of balance sheets in EXCEL financials ¢Don’t get hung up on the restrictive covenants in the paragraph called œFINANCING; STL has more important problems Write cases in standard English prose (paragraphs and sentences). Exclude repetition of material from the casebook. The only limit only the number of tables/graphs is discretion. Give a descriptive label for each table/graph. Put your assumptions in a table rather than in your write up. Write at least one paragraph in your write up on each scenario/table. Describe what the scenario models, how likely it is and which numbers are the most important. Interpret the important numbers. Exclude technical reviews saying how you divided A by B to get C or how you hacked up the “v.” Single-scenario solutions are penalized by a minimum of one letter grade. You should always test your spreadsheet to see how changes in risky variables change the output data. A good way to beat the plagiarism problem is to develop and discuss the spreadsheet model of a case, and then to go your separate ways and prepare and write up scenarios on your own. In the last paragraph, unequivocally state and defend your recommendations. Conceptually, a recommendation cannot be a scenario. STRONG TIE LTD. In early January 2009, David Johnstone received the draft 2008 financial statements for Strong Tie and began to question the company’s performance when compared to previous years. How were profits holding up, given the intense price competition in the industry? Were attempts to lower costs through more automation paying off? Were the current problems in the U.S. housing market going to continue to reduce demand for connectors? How would lenders react to this poor performance? Was the company’s financing in danger? After discussing the matter with company accountant Audrey Johnstone, it was decided that an outside consultant should be hired to provide an independent analysis of the company’s recent performance and to provide suggestions for future action. COMPANY BACKGROUND Strong Tie Ltd., located in Winnipeg, Manitoba, designed and manufactured the standardized and customized structural connectors used to reinforce wood joints in the construction of decks, fences, houses and other structures. Strong Tie was a family-owned corporation founded in 1946 by Bill Johnstone to capitalize on the high demand for housing as returning World War II veterans married and began families. Bill Johnstone died in 1975 but passed the business on to his son David, who continued to operate the business along with his three daughters, Ellen, Elizabeth and Audrey. David served as CEO, while Ellen Johnstone, P.Eng, was responsible for product design and production; Elizabeth Johnstone, CSP, managed marketing, sales and distribution; and Audrey Johnstone, CA, managed the company’s finances. The Johnstone family was a pillar of the Winnipeg business community, making sizeable donations to local charities and sport teams. The standardized connectors were designed in Winnipeg based on input from architects, draftsmen and builders. The production process was highly automated with metal cutting, stamping and drilling machines completing most of the tasks. Human intervention was required to transfer work-in-process between stations, to feed machines and to pack, store and distribute the end products. This automation had allowed production to remain in Canada to date despite fierce competition from low-wage countries, particularly China. Customized connectors were produced based on specifications provided by the customer. Production of these units was more labour-intensive, but margins were still significantly higher as contractors were prepared to pay a premium to have their special needs met. Strong Tie prided itself on its product design capabilities. Designers in Winnipeg consistently generated an array of new standardized connectors that improved on existing products or addressed newly identified industry needs. These products were described in detail in terms of dimension, strength (load-bearing weights and steel gauge) and installation on the company’s website or in a paper catalogue located in stores ” both were of very high quality. Strong Tie also had a reputation among construction professionals as providing innovative solutions to unique design requests and being able to produce customized products in a timely manner at a reasonable price. Standardized products were distributed through all national home improvement chains in North America including Home Depot, Lowe’s, Rona, Home Hardware, Eagle and Sears. Most local chains catering to contractors also carried the standardized products and accepted requests for customized connectors, which they then forwarded to Strong Tie. Strong Tie was estimated to have a 60 per cent market share, which had fallen from 70 per cent in recent years. Universal Connector, a U.S. firm based in Ohio, was estimated to have a 30 per cent and growing share; it offered a similar array of standardized products and customized design services. The remainder of the market was served by five Chinese producers whose market share had grown considerably in the last five years, although they had yet to enter the customized product segment. Universal Connector had closed a number of its U.S. manufacturing facilities in recent years and replaced them with new facilities in China, which put considerable downward pressure on industry prices. Currently, Strong Tie priced its products at a premium to its competitors because of its industry leadership. All sales were on terms Net 60. Large accounts such as Home Depot had a reputation of stretching their payments past the due date because of their buying power, while contractors frequently delayed payments due to cash flow problems. All purchases, which were primarily steel, were on terms 2/10, Net 60. Metal prices varied considerably, and the trend over 2006 to 2008 was for these prices to rise due to increasing demand from emerging market countries, particularly Brazil, Russia, India and China. Strong Tie had attempted to adopt just-in-time inventory practices to help reduce its raw material, work-in-process and finished goods inventory levels. The Johnstone family maintained excellent relations with its unionized workforce, which was represented by the United Steel Workers of America. They prided themselves on paying generous wages and providing their workers with excellent health care, disability and pension benefits. The company had never had a strike and was currently negotiating a new collective agreement to take effect in three months on April 1, 2009. In recent years, Strong Tie had been investing heavily in factory automation to improve its competitiveness. Automatic feeders and packaging equipment had been purchased to further reduce labour costs, and new computers and software had helped to speed up the design of high-margin customized connectors. A new, more automated warehouse had also been constructed. FINANCIAL STATEMENTS (I have included these statements in the attached excel document) FINANCIAL BENCHMARKS Reliable industry average information was not available for Strong Tie’s Chinese competitors, but comparable ratios were available for Universal Connector, a public company, in 2008. These ratios are contained in Exhibit 3. FINANCING Strong Tie had a $2,000,000, five-year, revolving credit agreement with the Bank of Nova Scotia, which was used to finance the company’s working capital requirements as well as a number of individual term loans to finance fixed assets. The revolving credit agreement was committed, so as long as the loan conditions were met, financing was guaranteed. The loan had to be secured 100 per cent by accounts receivable and inventory. The receivables were primarily with large retail chains that were in good financial health, so the Bank of Nova Scotia was prepared to lend 90 per cent of their value. They were also willing to lend 60 per cent of the value of the finished goods and work-in-process inventory because of a strong re-sale market and the short production process. The bank would only lend 40 per cent of the value of raw materials inventory due to general instability in the commodities market. The revolving credit agreement had to be paid down to zero at least once per year. All loans required that the company maintain a Current Ratio of 1.5 or higher, a Cash Flow Coverage Ratio of 1.0 or higher and a Long-term Debt to Total Capitalization Ratio of 40 per cent or less. Audited quarterly and annual financial statements also had to be provided to the bank each quarter. As the sole owner of the corporation, David Johnstone did not take a salary, but his three daughters received over $1,000,000 in salary and bonuses each year. Preferred dividends of $500,000 were paid out to Mr. Johnstone’s sister Katherine, who chose not to participate in the management of the business but was promised a regular income by her late father in lieu of receiving a share of the business. These dividends had to be paid unless the company entered bankruptcy. Cases In Managerial Finance For Senior Undergraduates. McGraw-Hill Create. VitalBook file. INCOME STATEMENTS 2006 2007 2008 Net Sales $16,200 $17,450 $16,500 Cost of Goods Sold 10,445 11,956 11,950 Gross Profit $5,755 $5,494 $4,550 Selling and Administration 3,054 3,130 3,379 Depreciation 396 720 756 Operating Income $2,305 $1,644 $415 Other Income Interest Income 21 10 2 Other Expense Interest Income 246 291 407 Income Before Taxes $2,080 $1,363 $10 Income Taxes 624 409 3 Net income $1,456 $954 $7 Unreasonable Assignments FIN 4422 Unreasonable Assignments Inc. Financial Statements “ millions of Puerto Rican $ CashFlow Forecast 2007 2008 2009 2010 2011 Net sales 270.0 280.8 292.0 g 0.026 S(1-t) 212.6 240.2 Cost of goods sold* 126.8 132.6 138.5 vS(1-t) -152.9 -172.8 Selling expense 33.8 35.1 36.5 Sub v 0.719 F(1-t) -20.7 -21.9 Research & Development 45.4 43.2 45.0 Regr v 0.638 Dt 3.7 3.9 General Expenses 28.0 28.5 30.0 R^2 0.960 Dwc -8.5 -10.3 Total costs 226.0 230.4 240.0 C[r] -10.6 -11.2 EBIT 36.1 41.4 42.1 Subj F 30.0 C[e] -18.0 -21.9 Interest 6.5 7.5 8.4 Regr F 53.0 ¾¾¾ ¾¾¾ ¾¾¾ Net Op CF 5.6 6.0 Earnings before tax 29.6 33.9 33.6 2009.0 2010.0 Tax 10.4 11.9 11.8 Est w 0.170 0.180 C 0.0 0.0 ¾¾¾ ¾¾¾ ¾¾¾ Δwc 0.0 0.0 Earnings after tax 19.3 22.0 21.9 Est c Setup(1-t) 0.0 0.0 Dividends 9.9 9.9 9.9 Subj 0.424 ¾¾¾ ¾¾¾ ¾¾¾ 0.955 Net decision CF 0.0 0.0 Added to Retained Earnings 9.4 12.1 12.0 R^2 0.99971 NET OPERATING CF 5.6 6.0 Cash 2.7 6.4 7.7 Interest(1-t) -5.5 -6.0 Inventory 48.6 50.5 52.6 Principal pmts -12.3 -12.3 Accounts Receivable 21.6 22.5 23.4 Common dividends -9.9 -9.9 ¾¾¾ ¾¾¾ ¾¾¾ Pref dividends 0.0 0.0 Current Assets 72.9 79.4 83.7 Lease pmts(1-t) 0.0 0.0 Gross Fixed Assets 135.0 154.0 175.0 Accumulated Depreciation -12.0 -21.0 -31.0 Fixed finanicial CF -27.7 -28.2 Net Fixed Assets 123.0 133.0 144.0 ¾¾¾ ¾¾¾ ¾¾¾ ΔDebt ± 0.0 0.0 TOTAL ASSETS 195.9 212.4 227.7 ΔEquity ± 0.0 0.0 ΔPreferred ± 0.0 0.0 Notes payable 12.0 25.0 42.5 ΔDividend 0.0 0.0 Accounts payable 16.2 19.7 17.5 Accruals 5.4 5.6 5.8 Net decision financial CF -27.7 -28.2 Current portion ” LTD 12.3 12.3 12.3 CATO -22.1 -22.2 ¾¾¾ ¾¾¾ ¾¾¾ Gross debt 105.2 115.0 124.9 Current Liabilities 45.9 62.6 78.2 t 0.35 LTD 75.0 62.7 50.4 v 0.72 Common stock 55.0 55.0 55.0 w 0.2 Retained Earnings 20.0 32.1 44.1 c 0.42 ¾¾¾ ¾¾¾ ¾¾¾ F 30.0 TOTAL LIABILITIES 195.9 212.4 227.7 GROWTH 0.12 0.13 0.14 INFLATOR 0.06 0.06 0.06 *Depreciation was 8.0 9.0 10.0 Note: year 2005 sales were: 233.0 SALES 292.0 327.0 369.6 & net fixed assets were: 119.0 Your growth rate for the 2009-2010 interval = 6.00% + the lowest digit in your student # Your inflator stays constant at 0.5 of the 2009-2010 growth rate; this does not mean inflator = 0.5 BE SURE TO HAND IN THIS SHEET WITH YOUR SOLUTION