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Hampton Machine Tool Company, a machine tool manufacturer, was founded in

1915. Hampton's customer base is made up primarily of military aircraft manufactures

and automobile manufacturers in the St. Louis area. Hampton felt the boom in the

1960 with record setting profits in the mid to late 1960. Hampton slowed down in the

1970s with the withdrawal from Vietnam War and the oil embargo. Hampton

stabilized by the late 1970s and now has a larger market share, as other competitors

were unable to make it through those tough times. Hampton¶s conservative financial

policy helped the firm to weather the business cyclical fluctuation in capital goods

industry, and had no debts on its balance sheet during ten years prior to 1978.

Traditionally, the company had kept its cash balances at St. Louis National Bank.

President of Hampton is Mr. Benjamin G. Cowins. He is 58 years old, widely

respected, energetic, successful and was a successor to his father in law.

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It is now September 14, 1979; President of Hampton Mr. Benjamin G. Cowins has

asked Mr. Eckwood for an extension to the end December 1979 on the $1 million

loan they took out from the St. Louis National Bank at the end of December 1978.

The loan was originally taken out on the terms of monthly interest payment at a rate

of 1.5% with the principle to be paid back at the end of September 1979. Hampton

also has asked for an additional $350,000 loan to also be repaid at the end of

December 1979 with interest payments monthly at the rate of 1.5%. The additional

loan is necessary for Hampton to update its machinery, which they have not done

since the economy went into a recession. The problem s are : Is Hampton Machine

Tool Company able to payback it's current loan and the additionally requested loan

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from the St. Louis National Bank, what action should Mr. Eckwood take on Mr.

Cowins¶ loan request, What are the major risks associated with the p roposed loan

and What other alternatives doe sMr. Eckwood have.

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Based on the information provided by Mr. Cowins, an analysis of cash funding and

usage that Hampton had from November 1978 to August 1979 is below:

Increase in bank debt $1,000,000 and Stock repurchase $3,000,000. Increase in

surplus from $2182, 000 to $2996, 000, Increase in customer advances $726,000

and in inventories by $2,163. Decrease in cash $ 961,000 and in accruals $9000.

Increase in accounts payable $600,000 and in taxes payable $329,000. Decrease in

accounts receivable $561,000, in net fixed assets $92,000 and Decrease in prepaid

expenses $20,000.

According the analysis above, there is a l arge amount of cash disburses because of

inventories that is negatively affect cash on hand that Hampton has. The total amo unt

of change in cash, customer advances and taxes payable is $2,016,000, which is not

able to cover the increase in inventory of $2,163,000. It appears a burden for

Hampton to have new financial obligation, and the company might be unable to repay

the whole amount at the end of 1979 . In addition, Hampton borrowed money from the

bank to meet long-term needs, stock repurchase and buying new equipment. So, it is

expected to take long time more than what originally intended to repay the

loanHowever, the loan is not considered highly risky from bank's

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Perspective, as Hampton is successful company that has long profitable history and it

expects huge increase in sales and return from September to December. Also, its

income has increased from $783,000 in 1978 to $914,000 in 1979 which lead to

increase earnings per share 3 times from $6.65 ($783 / 117.8) in 1978 to $21.36

(914/ 42.8) in 1979 after repurchasing 42,800 shares outstanding .

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This ratio is important to determine how profitable is the company and it will affect the

company access to debt finance, the valuation of company¶s common stock, the

willingness to issue stocks and sustainable growth rate of the company.

Net profit margin = net income after taxes/net sales.

‘ *an Feb March Apr May ‘  *uly Aug


‘ ‘
 ‘ ‘ ‘ 0.16 0.18 0.08 0.08 0.12 ‘  0.08 0.15
‘ 
‘ ‘ ‘  ‘ ‘ ‘ ‘ ‘ ‘ ‘

ROE = net income / equity. The higher the better

‘ March *une *uly Aug


‘ ‘ 0.05 0.04 0.02 0.02
‘ 
‘  ‘ ‘ ‘ ‘

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It indicates how well the company employs its assets. Ineffective utilization of assets

will result in additional need of finance; unnecessary interest cost and low return on

capital.

Asset turnover= sales / total assets

-
‘ March *une *uly Aug
‘ ‰‘ ‘ 0.27 0.22 .10 .06
‘    ‘ ‘

Inventory turnover = cost of goods sold / inventory

‘ March *une *uly Aug


‘ ! ‘ ‘ 0.39 0.37 .14 .06
‘     ‘ ‘

     

It measures the relationship of funds supplied by creditors and funds supplied by the

owner. Debt ratio = total liability / total assets. The lower the better.

‘ March *une *uly Aug


Debt ratio 0.57 ‘ 55 .56 .57
‘ total liability / total assets ‘ ‘

Interest coverage = earnings before I and T / interest expense

‘ March *une *uly Aug


Interest coverage .
earning before I and T / 19.93 19.53 8.40 11.00
‘ interest expense ‘ ‘

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It represents the company ability of company to repay short term obligations

‘ March *une *uly Aug


Liquidity ratio .
"‘ ‘‘‘ 1.51 1.58 1.57 1.54
‘  #   
‘ ‘

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It measures the ability of business firm to repay its short term obligation without using

its inventory.

‘ March *une *uly Aug


‘ ‰ $‘‘  ‘ .
"‘ ‘‘ 0.71 0.49
0.63 0.76
  ‘
 #   
‘
‘ ‘

Based on above ratios, Hampton has low and decreasing profitability and activity

ratios from March to August in 1979. That means the company is not using its assets

effectively to increase their sales and generate more profits, which might continue in

the coming month and negatively affect the ability of Hampton to pay back its debts

at the end of the year. Moreover, Hampton has stable and acceptable debt ratio, and

it is able to cover its interest expenses. The liquidity ratio is increasing which is

positive, but its acid test ratio is decreasing and below one, which m eans it, cannot

cover its short term debts without using or selling inventory. Therefore, Hampton

should control its inventory size by using effective inventory control policies.

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There are fife aspects that determine the creditwo rthy of the borrower: cash,

collaterals capacity, condition and character.

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Hampton has a relatively good creditworthy. Its cash was fluctuating and decreasing,

but it is able to generate more cash in the coming months, and it has other sources of

current assets to draw upon to repay its loans. Hampton has good options like

account receivable, inventory and common stocks that can be used by bank as

collaterals if Hampton did not repay the loan. Also, the owner is successful man, and

the company has big market share and good reputation.

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The bank has two options, either to accept or reject the Hampton's request. On the

other side, Hampton has different options to cover its need of cash:

1. Request additional fund of $ 350,000 from bank with extension of one $ million

existing loan to the end December 1979 at % 1.5 monthly interest rate.

2. Not pay dividends; this will save $150,000 but still leave them at a shortage of

cash. It may be costly because some stockholders could sell their share to ge t

capital gain which will decrease the value of shares

3. Hampton can start to repay some of the principle as soon as possible to

reduce the interest payments. This will help reduce the amount of interest paid

in total, however this solution does not eliminate the problem of still being in

shortage of cash and unable to repay the full loan .

4. They can look for an advance payment from one or many of their current

customers to help cover the shortfall. This may cause consumers to lose

confidence in Hampton and hurt their chance of repeat business. There is also

no grantee that customers will provide the advances.

5.