RE: HAMPTON MACHINE TOOL COMPANY TO: Jerry Eckwood, Vice President of St. Louis National Bank SECTION I St. Louis National Bank has to decide whether or not to grant a loan renewal request by a local company, Hampton Tool Company. The existing loan is due to be repaid in fifteen days and the president of the company, Benjamin Cowins, is also requesting an additional loan of $350,000 for planned equipment purchases in October 1979. Until December 1978, Hampton Tools had maintained a capital structure of zero debt.
In Dec. 1978, the company obtained a $1 million loan from St. Louis National Bank to use along with $2 million in excess cash for the repurchase of company stock from dissident shareholders. Hampton Tools was established in 1915 and experienced record production and profitability until around the mid-1970s. The decline in sales and profitability was due to massive reduction in demand because of the post-Vietnam War period and decline in automobile production in the St. Louis facilities.
Hampton’s eventual recovery was due primarily to the increase in military sales, the stabilization of the automobile segment of the company’s market, and economic conditions in the mid-1970s had taken their toll on the capital goods industry. Hampton’s conservative financial controls in the past have no doubt contributed to its survival and success in the capital goods industry. Section II The company experienced a short fall due to lack of cash resulting from the $2 million spent repurchasing the company’s stocks from the dissident shareholders.
Although the repurchase sacrificed the firm’s excess cash, the repurchase can be thought of as a positive move by the firm to produce large-scale changes in the company’s capital structure. Also, the repurchase may be viewed as a positive signal by investors that the company’s shares are undervalued. Another cause of the company’s short fall is the combination of dependent events and statistical fluctuations. The fact that Hampton has a backlog of orders and have been behind on shipping finished products for the last several months has cost the company over $1,320,000.
The company hasn’t been able to finish manufacturing a number of orders due to a delay in shipment of electronic components needed to complete the orders. This is a classic Supply chain management problem. The uncertainty of the company to trust the suppliers to deliver needed raw materials and sub-assemblies to them on time has resulted in the firm’s stock piling inventory as a buffer or insurance against this supply chain uncertainty. The result of this behavior is an increase in carry cost expenses for Hampton. Section III
After evaluating the current position of Hampton Machine Tool Company, it is apparent that the bank should extend the loan. When looking further into why a profitable firm like Hampton can’t pay its loan on time we came to the following conclusions: cash disbursements of three million dollars to buy out shareholders equaled 58% of total expenditures while inventory only accounted for 42%, shipments up-set by the supplier’s delay of sending electronic equipment which decreased the cash from past months, and also the overstock of raw materials by $420,000 all caused Hampton to have trouble paying back its loan on time.
Ultimately though, all these things caused a sharp increase in inventories which hindered the company’s ability to repay its loan. We also took the liberty to create financial statements and see if they could show us something we aren’t seeing, it seems though that the ending cash balance for Dec 1979 was ($331,000) and the cash plug from the pro forma balance sheet was also ($331,000) which are suppose to match. Going a step further we look to see if the ($331,000) could be paid off by Dec 1979 and it cannot.
Based on the projected cash budget it would not be possible to pay it all off but if the cash budget was extended early into 1980 it looks as if the loan could be taken care of. Mr. Eckwood would be doing the right thing by extended the requested loan. The loan amount could be paid in less than year, the company is having high returns, have a full year backlog of solid orders worth sixteen million dollars, all this leads to positive evidence that the loan will be repayable.
It should be noted though that Hampton will use the money to pay for new stock and new equipment which are both long term needs and using the money for long tern needs isn’t favorable from the banks position but it is still a good chance of being repaid with the given evidence. The impact of repurchasing the stock and of a potential dividend increase were also explored. Repurchasing the stock with the two million of excess cash reduced EPS from $18. 24 to $14. 6 which is still better than the EPS in 78’ at $6. 65. We do not agree with the decision to pay out such steep dividends. In 78’ the DPS were 50,000/117,800= . 42 while the proposed increase would bring DPS to 150,000/42,800= $3. 50. That is a 14 fold increase. We recommend increasing dividends but not by such leaps. With the said evidence and attached financial statements it is seen as a positive business decision to extend the loan to a reputable and profitable company such as Hampton Machine Tool.