Kevin Tame Finance Midterm

Palouse Case
Question 1

Source and Use

Actual 2003 - 2004

Source Use
NI $ 68,800 Dividends $ 43,000
Cash $ 25,800 AR $ 49,600
Accumulated Depreciation $ 3,700 Inventory $ 148,400
AP $ 108,200 Deferred Charge $ 400
Misc Acc $ 1,500 Purchase FA $ 57,900
Taxes Payable $ 16,300
Bank Loan (Current) $ 25,000
Bank Loan (LT) $ 50,000

Total $ 299,300 Total $ 299,300

Forecasted 2003 - 2004

Source Use
NI $ 65,000 Dividends $ 43,000
Cash $ 27,500 AR $ 18,400
Accumulated Depreciation $ 3,300 Inventory $ 17,400
Taxes Payable 14000 Deferred Charge $ 600
EFN $ 11,200 Purchase FA $ 40,000
AP $ 1,000
Misc Acc $ 600

Total $ 121,000 Total $ 121,000

Question 2

There are four major areas of deviation that should carefully be examined. Inventory, Accounts
Payable, Cash and Dividends are all out of the ordinary for a high growth firm. First, the sudden
increase in inventory raises many concerns. Why is this company forecasting that they will only
have an increase of inventory by $17,000 but actual increase to $148,400? This drastic increase
is not a direct correlating to sales as might be assumed. On the contrary, Sales have only
increased by 20% while inventory has increased by a startling 89% and as a result require excess
financing. Accounts Payable become this financing option and as a result have a drastic increase
of 500% ($108,000). The next obvious concern is in regard to the source and use of cash and
dividends. Traditionally, a high growth firm needs to focus on building it’s cash. Remember,
“Cash is King.” Increasing a dividend payout is foolish in the firms current state and it is better
for such firms to reinvest back into the company. Inventory is a critical issue that needs to be
addressed, however that cash and dividend is also a disconcerting problem.
Kevin Tame Finance Midterm

Question 3

Since the balance sheet is a snap shop of where the firm is at any given point $11,200 is not an
accurate reflection of the financing that might be needed through out the year. It is very plausible
that the company might need financing in the summer months that exceed the stated $11,200.
More information such as quarterly or monthly reports would help to make a more accurate
forecast.

Question 4

For the most part, by looking at the forecast and doing a ratio analysis, a banker should assess
that the firm is stable. However, one concern, that was mentioned in question one, should have
been addressed by the banker. Cash and the dividend payment are somewhat out of the ordinary
for a growth firm and should be treated differently. The Dividend Payout for Palouse is 66%.
Paying 66% of your Net Income is a lot of money that could have been used for growth inside
the company. This oversight of the bank could have easily been addressed and some of the
problems that Palouse is facing could have been avoided.

Question 5

Ratio Analysis

2003 Forecasted 2004 2004

Margin NI/Sales 4.34% 5.58% 4.35%

Turnover Sales/TA 2.59 2.77 2.63
ROI Margin*Turnover 11.22% 15.45% 11.43%
D/A TD/TA 13.81% 15.26% 41.99%
ROE ROI/(1-D/A) 13.02% 18.23% 19.70%

FA Turn Sales/Net FA 38.05 18.72 19.86

CA Turn Sales/CA 2.83 3.32 3.08
Current CA/CL 6.61 5.46 2.54
Quick CA-INV/CL 3.41 2.61 0.99
Inventory TO Cost of Sales/Inv 3.80 4.00 3.35
A/R Collection A/C/(Sales/365) 46.64 44.63 40.02
Cash Cash from BS $52,500 $25,000 $26,700
A/P Days outstanding AP/(Purchases/365) 12.17 10.16 39.53
Dividend Payout Dividend/NI 66.51% 66.15% 62.50%

CD/TD CD/TD 100% 100% 80%

LTD/OE LTD/OE 0% 0% 14%
NW/TA NW/TA 86% 82% 58%
Kevin Tame Finance Midterm

Dupont Analysis
• Profitability
• They had an increase in profit in 2004. An increase of 64%
• ROE had an increase of 13.02% to 19.70% but Margin and Turnover had little growth.
• Operating Standpoint
• A/P Collection Period
• They began to stretch their suppliers by paying them in an average of 40 days in
contrast to the 12 day average they had in 2003. This is not a good long term solution
because it can cause poor supplier relations and is not a long term source of financing
because it is only created by stretching out payment days.
• A/R Collection Period
• They began collecting faster on their accounts receivable reducing them by 6 days.
• Current and Quick Ratio
• As a result of picking up debt their quick and current ratio falls. It does not fall to a
terrible number but it is important to consider that it did fall.
• Turnover
• There was a slight improvement however but nothing truly significant.
• Inventory
• Inventory Turnover decreased due to the build up to 89% of excess inventory.
• Cash
• Decreasing cash is not normal for a growth firm.

Palouse is not able to keep up with the rapid growth that it is experiencing. Also, what makes the
situation even more baffling is that they continue to pay a hefty dividend. At their current state
they will not last another year or two.

Question 6

Repayment

2005

A/R Collection 77% $ 134,463.56

A/P Payment 78% $ 102,019.73
Cash $ 26,700.00
Op Exp $ 34,958.33
Money Left for Paying Loan $ 24,185.50
Loan Payment $ 25,000.00
Money Needed to Pay Off Loan $ (814.50)
Paluose is unable to pay it’s loan off with it’s current condition.
Kevin Tame Finance Midterm

Question 7
Decision Tree

The banker has very little options at this point from a collection standpoint because Palouse
cannot pay off their loan without going out of business. The banker has switched roles to the
extent he must now act as a financial advisor. His best approach, to handling the situation, is to
Kevin Tame Finance Midterm

explain to Palouse the implications of having excess inventory and using A/P to finance it. He
should also make the firm aware by paying a dividend they are not able to keep up with the rapid
growth they are experiencing. The very first thing the banker should do is extend the loan under
the conditions that the firm will lower their inventory and decrease the amount of days it takes
for them to pay off their accounts. Also an important things that the firm could do is stop paying
a dividend. It is crucial for the company to stay in business. The purpose of a dividend is to
entice people to buy stock and since Palouse is a high growth firm there is already people who
most likely would still wish to own the stock even without dividends. The most important thing
to remember is that if the company fails no one will have stock. The firm should let the
stockholders know the current position of the firm and explain that they will no longer be paying
a dividend. This will save the company large amounts of cash and allow them to expand with
less assistance from external funds.