Padgett Paper
Essay by review • May 24, 2011 • Research Paper • 1,171 Words (5 Pages) • 1,601 Views
Case Solution Outline
-Summary
-Company
-Market
-Product
-Projections
-Options
-Current Capital Structure
-Proposed Capital Structure
-Review
Summary
Objective: To find a mutually acceptable debt structure that will
minimize lender risk while increasing company value.
Constraints: 1) realistic cash flow projections, 2) Bank safety levels
Situation for each Business Group
Bank: Over extended and is in a bad situation. Lending exceeds reasonable levels and is not collateralized or subject to convenants.
A $8 million loan is abnormal for the bank. The companies management does not appear to understand the unrealistic debt
situation, the impact on firm value and impact on the upcoming audit report.
Management: Has unrealistic expectations and a lack of understanding of impact of current structure of firm value.
Company: The company has considerable levels of equity and is not maximizing its financial structure. It is capable of taking on
considerably more debt, however, the debt needs to be more appropriately structured.
Ownership: Closely-held company with owner having little interest in management. Owned for dividend distribution.
The Company Background
1. Closely held public company (OTC)
2. MFG stationery including notebooks, loose leaf binders, filler paper
3. 100 years old
4. Management is professional but not finance savvy
5. Customers: 5,000 wholersalers and retailers in US & Canada (not subject to concentrations)
6. Seasonal cash needs - back to school push
7. Minor acquisitions, until recent purchase of Tri-Star
The Market
-Consolidations
-Larger companies begin to dominate
-Thinning margins
-Price of paper increases
-Increased international competitors
Key Operating Ratios
1993 1994 1995 1996
Operating Expenses 22.1 25.6 26.4 26.5
Gross Profit % 40.3 39.1 38.7 38.8
Pre-Tax Margin 17.9 13.5 11.8 11.5
After Tax Margin 7.6 6.6 5.8 6.3
-Operating margins have declined due to competition and rising paper prices.
Product
-Stationery including notebooks, loose leaf binders, filler paper
-Low margins business
-Seasonal business (Back to School dominates)
Current Capital Structure
-Too much short-term debt
-90 day terms
-Significant level of equity - D/E is not maxmimized and value from tax shield is lost
Options
-Portion of debt through insurance company
-Continue at 90 day terms
-Factor receivables
-Collateralize assets
-Mortgage general purpose building
-Independent Canadian Financing
-Flat dividends
-Payment Terms - accelerate receipt
-LIFO / FIFO
Pros and Cons of Options
Debt through insurance company
Pros: longer maturity schedule, reduce risk to bank and company
Cons: Management is against this option due to restrictive convenants and interest rate uncertainty
Recommendation: This could be used as a second tier of leverage, to increase debt levels as needed. But not necessarily needed
now.
Continue at 90 day terms
Pros: Management likes
Cons: Subject to short term rate increases, going concern issues with upcoming audit, Callable in 90 days, no collateral or covenants,
bank management is negative on situation, significant distress costs reduce stock value.
Recommendation: Not an acceptable option
Factor Receivables
Pros: Increase cash flow, payroll savings in collections and credit departments, reduces risk to bank and bank's required
due-dillegence in regards to collateralized receivables.
Cons: Additional costs associated with factoring
Recommendations: Not advised as a first tier method, but we recommend the company pursue a relationship with a factoring firm to
allow
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