From the point of view as the bank creditor, Jerry Eckwood, a determination must be made of whether Hampton Machine Tool Company should receive an extension of their original loan of $1 million, as well as an additional loan of $350,000. After research and careful consideration and extraneous research and forecasting, we, St. Louis National Bank, as well as myself, Jerry Eckwood, have determined to reject Hampton Machine Tool Company’s loan request, as well as the loan extension request. Based off of conducting a financial analysis, primarily on the cash budget, our forecasting has shown that Hampton Machine Tool Company would not be able to fully repay their loan of $1.35 million by the end of the year (1979). However, we have determined that Hampton Machine Tool Company would be able to fully repay their loan in January. Therefore, we are offering a proposal to extend the loan for another month, but with an increased interest rate.
Not only will this allow you to repay your loans in full, but it will also provide you with the necessary funding that you are requesting. The re-negotiation of the terms of the loans would include the following: the deadline of the payment would increase to January, while the interest rate would increase to 1.75%. This will ensure that the loan will be repaid on time and will allow Hampton Machine Tool Company to purchase their new equipment to assist with operation needs. In order to make our decision, we reviewed Hampton Machine Tool Company’s financial ratios, as well as their cash budget. While analyzing the profitability ratio, it came to our attention that these ratios were unstable, but showed signs of significant improvement. The ratios that stuck out to us were the significant increase in operating profit margin and gross profit margin. This increase was based mainly off of the historical trend compared to the project financial statements.
While the gross profit margin had its only decrease in September, we can safely trace this to the reduction of WIP inventory of $1,320 during this month. This reduction in WIP concludes that Hampton Machine Tool Company would be operating at a loss of -13% during the month of September. However, we must take into account that profitability will greatly increase three months prior due to the backlog in inventory and customer orders. Therefore, we determined that Hampton Machine Tool Company would be an acceptable client to extend credit to. When determining liquidity, we based our determinations off of the project financial statements. These concluded that Hampton Machine Tool Company’s quick ration is currently below 1, and has been for some time. A quick ratio below 1 shows that a company’s liabilities are greater than its assets, which can lead to a greater chance of depending on inventory to cover some obligations for payment.
Our main conclusion to reject Hampton Machine Tool Company’s offer was determined based off of their current cash budget. As shown in Exhibit B, we determined that Hampton Machine Tool Company would perform well once their equipment was improved with the loan. It was also concluded from this exhibit that additional borrowings would not be necessary to fund operations due to their potential ending cash balances. Exhibit D shows that Hampton Machine Tool Company would still have a possibility of a negative cash balance in December if they postponed paying dividends. When factoring in the December sales and the accounts receivable from them, Hampton Machine Tool Company would still be unable to fully repay the loan in December.
Extending the loan to January would make the most sense, allowing them time to accumulate the appropriate cash to repay the loan in full. As stated above, our decision to reject Hampton Machine Tool Company’s loan extension request was primarily based off of their current cash budget. Our proposal is to extend the loan to January, with an interest rate increase to 1.75%. The acceptance of this proposal will grant Hampton Machine Tool Company excess time to repay the loan, which will simultaneously remove it from their liabilities.
As for the St. Louis National Bank, we feel confident that providing an extension into January will allow Hampton Machine Tool Company sufficient time to turn profits and fully repay their loan. Along with this, the bank will receive additional payments due to the increase in the interest rate. Furthermore, if Hampton Machine Tool Company is unable to repay the loan in January, penalties would incur, based on the discretion of the bank and amount still owned by Hampton Machine Tool Company.