Mark X Company manufactures farm and specialty trailers of all types. More than 85% of the...

 

  
 

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Mark X Company manufactures farm and specialty trailers of all types. More than 85% of the company's sales come from the western part of the United States, particularly California, although a growing market for custom horse transport vans designed and produced by Mark X is developing nationally and even internationally. Also, several major boat companies in California and Washington State have had Mark X design and manufacture trailers for their new models, and those boat trailer "packages" are.sold through the boat companies' nationwide dealer networks. Steve Wing, the president of Mark X, recently received a call from Karen Dennison, senior vice president of Wells Fargo Bank. Karen told Steve that a deficiency report generated by the bank's computerized analysis system had been filed because of Mark X's deteriorating financial position. The bank requires quarterly financial statements from each of its loan customers. Information from such statements is fed into the computer, which then calculates key ratios for each customer and charts trends in these ratios. The system also compares statistics and metrics for each company with the average ratios of other firms in the same industry and against any protective covenants in the loan agreements. If any ratio is significantly worse than the industry average, reflects a marked adverse trend, or fails to meet contractual requirements, the computer highlights the deficiency. The latest deficiency report on Mark X revealed a number of significant adverse trends and several potentially serious problems (see tables 1 through 6 for Mark X historical financial statements). Particularly disturbing were the 2015 current, quick and debt ratios, all of which failed to meet the contractual commitments of 2.0, 1.0, and 55% respectively. Technically the bank had a legal right to call all the loans it had extended to Mark X for immediate repayment and, if the loans were not repaid within 10 days, to force the company into bankruptcy. Karen hoped to avoid calling the loans if possible, as she knew that this would create a problem that Mark X could not survive. Still, her own bank's examiners had recently become highly sensitive to problem loans, because of the increased number of bank failures due to the financial crises in recent years. This forced regulators to be stricter in their examinations of bank loan portfolios and to demand earlier identification of potential repayment problems. To keep Mark X's loan from becoming reclassified as a "problem loan", the Senior Loan Committee will require strong and convincing evidence that the company's present difficulties are only temporary. Therefore, it must be shown that appropriate actions to overcome the problems have been taken and that the chances of reversing the adverse trends are realistically good. Karen now has the task of collecting the necessary information, evaluating its implications, and preparing a recommendation for action. The financial crises that plagued the US economy since 2009 had caused severe, though hopefully temporary, for companies like Mark X. farm commodity prices have remained low, thus farmers have held their investments in new equipment to the bare minimum. On top of this, a luxury tax, imposed recently has had a disastrous effect on top-of-the-line boat/trailer sales. Finally, the last Tax Reform Act reduced many of the tax benefits associated with horse breeding, leading to a drastic curtailment of demand for new horse transport vans. In light of the softening demand, Mark X had aggressively reduced prices in 2014 and 2015 to stimulate sales. This, the company believed, would allow it to realize greater economies of scale in production and to bring the learning curve down to a lower cost position. Mark X's management had full confidence that national economic policies would revive the ailing economy and that the downturn in demand would be only a short term problem. Consequently, production continued unabated, and inventories increased sharply. In an effort to reduce inventory, Mark X relaxed its credit standards in early 2014 and improved its already favorable credit terms. As a result, sales growth did remain high by industry standards through the third quarter of 2015, but not high enough to keep inventories from continuing to rise. Further, the credit policy changes had caused accounts receivable to increase dramatically by late 2015. To finance its rising inventories and receivables, Mark X turned to the bank for a long term loan in 2014 and also increased its short term credit lines in both 2014 and 2015. However, this expanded credit was insufficient to cover the asset expansion, so the company began to delay payments of its accounts payable until the second late notice had been received. Management realized that this was not a particularly wise decision for the long run, but they did not think it would be necessary to follow the policy for very long. They predicted that the national economy would pull out of the weak growth scenario in late 2015. Also, there has been talk in Congress of killing the luxury tax and giving back some of the tax benefits to horse breeders. Thus, the company was optimistic that its stable and profitable markets of the past would soon reappear. After Karen's telephone call, and the subsequent receipt of a copy of the bank's financial analysis of Mark X, Steve began to realize just how precarious his company's financial position had become. As he started to reflect on what could be done to correct the problems, it suddenly dawned on him that the company was in even more trouble than the bank imagined. Steve had recently signed a firm contract for a plant expansion that would require an additional $6,375,000 of capital during the first quarter of 2016, and he had planned to obtain this money with a short term loan from the bank to be repaid from profits expected in the last half of 2016 as a result of the expansion. In his view, once the new production facility went on line, the company would be able to increase output in several segments of the trailer market. It might have been possible to cut back on the expansion plans and to retrench, but because of the signed construction contracts and the cancellation charges that would be imposed if the plans were cancelled, Steve correctly regards the $6,375,000 of new capital as being essential for Mark X's survival. Steve quickly called his senior management team in for a meeting, explained the situation, and asked for their help in formulating a solution. The group concluded that if the company's current business plan were carried out, Mark X's sales would increase by 10% from 2015 to 2016 and by another 15% from 2016 to 2017. Further, they concluded that Mark X should reverse its recent policy of aggressive pricing and easy credit, returning to pricing that fully covered costs plus normal profit margins and to standard industry credit practices. These changes should enable the company to reduce the cost of goods sold to from over 85% of sales in 2015 to about 82.5% in 2016 and then to 80% in 2017. Similarly, the management group felt that the company could reduce administrative and selling expenses from almost 9% in 2015 to 8% in 2016 and to 7.5% in 2017. Significant cuts should also be possible in miscellaneous expenses, which should fall from 2.92% of 2015 sales to approximately 1.75% of sales in 2016 and to 1.25% in 2017. Further to appease suppliers, future bills would be paid more promptly, and, to convince the bank how serious management is about correcting the company's problems, cash dividends would be eliminated until the firm regains its financial health. Assume that Steve has hired you as a consultant to first verify thed bank's evaluation of the company's current financial position and then to put together a forecast of Mark X's expected performance for 2016 and 2017. Steve asks you develop some figures that ignore the possibility of a reduction in the credit lines and to assume that the bank will increase the line of credit by the $6,375,000 needed for the expansion and supporting working capital. Also, you and Steve do not expect the level of interest rates to change substantially over the two year forecast period; however, you both think that the bank will charge 12% on both the additional short term loan if it is granted, and on the existing short term loans, if they are extended. The assumed 40% combined federal and state tax rate should also hold for the two years. Finally, if the bank cooperates and if Steve is able to turn the company around, the P/E ratio should be 10 in 2016 and rise to 12 in 2017. Question: Based on your analysis, does it a ppear that the bonk should lend the requested money to Mark X? Explain. Mark X Company manufactures farm and specialty trailers of all types. More than 85% of the company's sales come from the western part of the United States, particularly California, although a growing market for custom horse transport vans designed and produced by Mark X is developing nationally and even internationally. Also, several major boat companies in California and Washington State have had Mark X design and manufacture trailers for their new models, and those boat trailer "packages" are.sold through the boat companies' nationwide dealer networks. Steve Wing, the president of Mark X, recently received a call from Karen Dennison, senior vice president of Wells Fargo Bank. Karen told Steve that a deficiency report generated by the bank's computerized analysis system had been filed because of Mark X's deteriorating financial position. The bank requires quarterly financial statements from each of its loan customers. Information from such statements is fed into the computer, which then calculates key ratios for each customer and charts trends in these ratios. The system also compares statistics and metrics for each company with the average ratios of other firms in the same industry and against any protective covenants in the loan agreements. If any ratio is significantly worse than the industry average, reflects a marked adverse trend, or fails to meet contractual requirements, the computer highlights the deficiency. The latest deficiency report on Mark X revealed a number of significant adverse trends and several potentially serious problems (see tables 1 through 6 for Mark X historical financial statements). Particularly disturbing were the 2015 current, quick and debt ratios, all of which failed to meet the contractual commitments of 2.0, 1.0, and 55% respectively. Technically the bank had a legal right to call all the loans it had extended to Mark X for immediate repayment and, if the loans were not repaid within 10 days, to force the company into bankruptcy. Karen hoped to avoid calling the loans if possible, as she knew that this would create a problem that Mark X could not survive. Still, her own bank's examiners had recently become highly sensitive to problem loans, because of the increased number of bank failures due to the financial crises in recent years. This forced regulators to be stricter in their examinations of bank loan portfolios and to demand earlier identification of potential repayment problems. To keep Mark X's loan from becoming reclassified as a "problem loan", the Senior Loan Committee will require strong and convincing evidence that the company's present difficulties are only temporary. Therefore, it must be shown that appropriate actions to overcome the problems have been taken and that the chances of reversing the adverse trends are realistically good. Karen now has the task of collecting the necessary information, evaluating its implications, and preparing a recommendation for action. The financial crises that plagued the US economy since 2009 had caused severe, though hopefully temporary, for companies like Mark X. farm commodity prices have remained low, thus farmers have held their investments in new equipment to the bare minimum. On top of this, a luxury tax, imposed recently has had a disastrous effect on top-of-the-line boat/trailer sales. Finally, the last Tax Reform Act reduced many of the tax benefits associated with horse breeding, leading to a drastic curtailment of demand for new horse transport vans. In light of the softening demand, Mark X had aggressively reduced prices in 2014 and 2015 to stimulate sales. This, the company believed, would allow it to realize greater economies of scale in production and to bring the learning curve down to a lower cost position. Mark X's management had full confidence that national economic policies would revive the ailing economy and that the downturn in demand would be only a short term problem. Consequently, production continued unabated, and inventories increased sharply. In an effort to reduce inventory, Mark X relaxed its credit standards in early 2014 and improved its already favorable credit terms. As a result, sales growth did remain high by industry standards through the third quarter of 2015, but not high enough to keep inventories from continuing to rise. Further, the credit policy changes had caused accounts receivable to increase dramatically by late 2015. To finance its rising inventories and receivables, Mark X turned to the bank for a long term loan in 2014 and also increased its short term credit lines in both 2014 and 2015. However, this expanded credit was insufficient to cover the asset expansion, so the company began to delay payments of its accounts payable until the second late notice had been received. Management realized that this was not a particularly wise decision for the long run, but they did not think it would be necessary to follow the policy for very long. They predicted that the national economy would pull out of the weak growth scenario in late 2015. Also, there has been talk in Congress of killing the luxury tax and giving back some of the tax benefits to horse breeders. Thus, the company was optimistic that its stable and profitable markets of the past would soon reappear. After Karen's telephone call, and the subsequent receipt of a copy of the bank's financial analysis of Mark X, Steve began to realize just how precarious his company's financial position had become. As he started to reflect on what could be done to correct the problems, it suddenly dawned on him that the company was in even more trouble than the bank imagined. Steve had recently signed a firm contract for a plant expansion that would require an additional $6,375,000 of capital during the first quarter of 2016, and he had planned to obtain this money with a short term loan from the bank to be repaid from profits expected in the last half of 2016 as a result of the expansion. In his view, once the new production facility went on line, the company would be able to increase output in several segments of the trailer market. It might have been possible to cut back on the expansion plans and to retrench, but because of the signed construction contracts and the cancellation charges that would be imposed if the plans were cancelled, Steve correctly regards the $6,375,000 of new capital as being essential for Mark X's survival. Steve quickly called his senior management team in for a meeting, explained the situation, and asked for their help in formulating a solution. The group concluded that if the company's current business plan were carried out, Mark X's sales would increase by 10% from 2015 to 2016 and by another 15% from 2016 to 2017. Further, they concluded that Mark X should reverse its recent policy of aggressive pricing and easy credit, returning to pricing that fully covered costs plus normal profit margins and to standard industry credit practices. These changes should enable the company to reduce the cost of goods sold to from over 85% of sales in 2015 to about 82.5% in 2016 and then to 80% in 2017. Similarly, the management group felt that the company could reduce administrative and selling expenses from almost 9% in 2015 to 8% in 2016 and to 7.5% in 2017. Significant cuts should also be possible in miscellaneous expenses, which should fall from 2.92% of 2015 sales to approximately 1.75% of sales in 2016 and to 1.25% in 2017. Further to appease suppliers, future bills would be paid more promptly, and, to convince the bank how serious management is about correcting the company's problems, cash dividends would be eliminated until the firm regains its financial health. Assume that Steve has hired you as a consultant to first verify thed bank's evaluation of the company's current financial position and then to put together a forecast of Mark X's expected performance for 2016 and 2017. Steve asks you develop some figures that ignore the possibility of a reduction in the credit lines and to assume that the bank will increase the line of credit by the $6,375,000 needed for the expansion and supporting working capital. Also, you and Steve do not expect the level of interest rates to change substantially over the two year forecast period; however, you both think that the bank will charge 12% on both the additional short term loan if it is granted, and on the existing short term loans, if they are extended. The assumed 40% combined federal and state tax rate should also hold for the two years. Finally, if the bank cooperates and if Steve is able to turn the company around, the P/E ratio should be 10 in 2016 and rise to 12 in 2017. Question: Based on your analysis, does it a ppear that the bonk should lend the requested money to Mark X? Explain.

Answer rating: 100% (QA)

Answer The assertion Especially upsetting were 2015 current fast and obligation proportion which neg... View the full answer