Financial Analysis Of Hampton Machine Tool Company

Introduction:

Hampton Machine Tool Company, a machine tool manufacturer, was founded in 1915. Until 1979, the company had successfully forecasted the severe cyclical fluctuations characteristic of the industry. The company’s primary customer base included the aircraft and automobile manufacturers in the St. Louis area. During the mid – to late 1960s, Hampton was very profitable due to a strong automobile market, and, to the heavy defense spending associated with the Vietnam War. However, in the mid-1970s, Hampton’s profitability slowed down with the United States’ withdrawal from Vietnam War and the oil embargo. By the late 1970s, they had a larger share in the market due to their competitors who were unable to make it through these difficult times, while Hampton managed to stabilize.

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Case Background:

Ten years prior to December, 1978, the company had no debt because it had conservative financial policies, which maintained a strong working capital position as a buffer against economic uncertainty. In December,1978, Hampton requested a $1 million loan from the St. Louis National Bank. The loan’s terms were a monthly interest payment at a rate of 1.5%, with the principal to be paid back at the end of September, 1979. Now (September of 1979), Benjamin G. Cowins, president of Hampton, has asked to renew the initial loan until end of 1979, and, has requested an additional loan of $350,000 with promise of repayment at the end of December, 1979 with an interest rate of 1.5% per month. This additional loan is required for an update of their machinery which hasn’t been done since the economy went into a recession in the early 1970s.

For the last several months, Hampton’s shipment schedule has been upset because they have had to wait for parts from their suppliers. On August 31, the accumulation of seven machines cost about $1,320,000, in addition to the installation cost for these parts. They received the parts last week, and will be able to complete a number of machines within next few weeks. The reduction in work in progress of about $1,320,000 is due to not receiving the electronic control mechanisms on time. However, the remainder of their work in progress inventories will probably remain steady for the foreseeable future because of their capacity rate of production.

In July and August, Hampton bought raw materials beyond their immediate needs to be assured of completing their order schedule to be shipped by the end of the year. Therefore, they currently have accumulated about $420,000 worth of scarcer components above their normal raw materials inventories. They estimate it will be used by the end of the year. Because they bought ahead this way, they expect to cut raw material purchases to about $600,000 a month in each of the four remaining months of 1979.

The company’s revised shipment estimates are: September, $2,163,000; October, $1,505,000; November $1,604,000; December, $2,265,000. The shipment estimates include a $2,100,000 order for the General Aircraft Corporation. Hampton is now scheduled to ship against this order as follows: September, $840,000; October, $840,000; November, $420,000. Because General Aircraft gave Hampton an advance payment of $1,566,000 on this order, the company will be due nothing on these shipments until their $1,566,000 credit with Hampton is exhausted.

Hampton’s assuming accruals will remain about the same on August 31, and their monthly outlay for all expenses other than interest and raw materials purchases should be around $400,000 per month. Due to poor economic conditions and the company’s desire to conserve cash; they have spent little on new equipment in the last several years, 1979. This has contributed somewhat to the difficulties they have had in maintaining production at full capacity this year. As a result, Hampton has requested an additional $350,000 loan at an interest rate of 1.5% monthly, with promise of repayment at the end of December, 1979. This loan is necessary to purchase certain needed equipment to maintain the production. The tax people estimated the equipment will qualify for a 10% investment tax credit. The company is scheduled to pay $181,000 in taxes on September 15 and December 15. Also, Mr. Cowins has suggested paying $150,000 dividends to stockholders in December.

Analysis:

The Hampton Machine Tool Company is facing problems in paying its $1 million loan and requesting for a new loan from the St. Louis National Bank. By following Mr. Cowins’ plan, the company will be short $332,000 (Exhibit 1) in December. Hampton, a profitable firm, has fallen behind on their orders, and Mr. Cowins recommends that they need more financing to purchase certain needed equipment. Hampton has notified the St. Louis National Bank that they will not be able to repay in September. Also, they have requested an extension. For the past month or more, Hampton has been operating at full capacity, and with additional back orders, which has put them behind in their shipment of orders. In addition, their shipment schedule has been upset because they have been waiting for electronic control mechanisms from their suppliers. The falling behind has also caused them to have less than what is needed for accounts receivables turnover.

The cash budgets and statement of sources and uses yield negative results concerning the principal payment of the loan for December (Exhibit 1), based on Mr. Cowins’ plan. This analysis is based on projected sales, dividend payments and tax payments. Consequently, the sales projects and accounts receivables are 30 days net; if not paid on time, then this could change the results significantly by putting the company in more of a financial bind. Based on my forecasts it seems that Mr. Cowins is incorrect about being able to repay the loan in December, but Hampton should be able to repay in January with more precise planning.

Hampton used the initial loan plus $2 million in excess cash to repurchase a substantial fraction of its outstanding common stock, because it had decreased sufficiently in value. Although they had good intentions to increase the company’s stock value, their finances have suffered because of the repurchase. Mr. Cowins’ offer to pay $150,000 in dividends in December is not reasonable, because Hampton’s finances will suffer, causing them to have negative cash flows. (Exhibit 1)

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Recommendation:

It is obvious that Hampton cannot afford to repay the loan in December, if they proceed with their original plans. The company will have a negative cash flow in December according to Exhibit 1. They should request a one-month extension on the loan, as they cannot afford to make a loan payment in December. Extending the loan repayment one month until January allows for account receivables of December to become collected, because of the company collection policy of 30 days net. This means Hampton will not have to go into the negative to pay the loan in December, keeping cash flow at an expectable level which is $1,168.50. (Exhibit 2)

Hampton cannot afford to make a dividend payment in December, regardless of their willingness to do so. Canceling the dividend payment will free up $150,000 in December, keeping the net cash flow in the positive (Exhibit 2), which compensates for the $350,000 loan payment. This also helps keep the net cash flow positive in December, as well as waiting for accounts receivables of $2,265,000 to come in January for the final payment. This makes the company profitable for the future, and, in turn, the stock will not become valueless.

Conclusion:

My recommendation for Hampton Machine Tool Company is they should request a one month extension on the loan, and cancel the dividend payment to make the company more profitable. Also, this would strengthen Hampton’s relationship with the bank by paying off both loans.

Based on the forecasted cash budget, Mr. Jerry Eckwood, vice-president of the St. Louis National Bank, should reject the $350,000 loan request based on the current terms proposed by Hampton Machine Tool Company. According to Exhibit 1, there is an inability to repay the initial loan. The numbers fall short of being able to repay the original loan in December without even considering the requested loan. However, with the proper financial adjustments, both loans can be fully repaid by January. For relationship reasons, Mr. Eckwood may want to grant the loan, as long as the terms are reworked to help guarantee, that the bank will get paid. The extension of the loan and cancelation dividends will leave Hampton in a manageable situation, allowing them to continue to be a profitable customer of the bank. The St. Louis National Bank should bring up the solutions that I mentioned above, but Mr. Eckwood will want to make sure that the bank puts Hampton on a repayment plan, so, that in the near future they can expect to collect the principal of the outstanding loans.

If I was the St. Louis National Bank, I would have to reject the loan on the current terms proposed by Mr. Cowins, because the Hampton Machine Tool Company shows an inability to repay the loan, based on the numbers they have forecast.