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Analysis Of Hampton Machine Tool Company FinancingFinance EssayIntroduction:Hampton Machine Tool Company, a machine tool manufacturer, was founded in 1915. Until 1979, thecompany had successfully forecasted the severe cyclical fluctuations characteristic of the industry. Thecompanys 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 heavydefense spending associated with the Vietnam War. However, in the mid-1970s, Hamptons profitability sloweddown with the United States withdrawal from Vietnam War and the oil embargo. By the late 1970s, they had alarger share in the market due to their competitors who were unable to make it through these difficult times, whileHampton managed to stabilize.

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 loans terms were a monthly interestpayment at a rate of 1.5%, with the principal to be paid back at the end of September, 1979. Now (September of1979), Benjamin G. Cowins, president of Hampton, has asked to renew the initial loan until end of 1979, and, hasrequested an additional loan of $350,000 with promise of repayment at the end of December, 1979 with aninterest rate of 1.5% per month. This additional loan is required for an update of their machinery which hasntbeen done since the economy went into a recession in the early 1970s.

For the last several months, Hamptons shipment schedule has been upset because they have had to wait forparts from their suppliers. On August 31, the accumulation of seven machines cost about $1,320,000, in additionto the installation cost for these parts. They received the parts last week, and will be able to complete a number ofmachines within next few weeks. The reduction in work in progress of about $1,320,000 is due to not receiving theelectronic control mechanisms on time. However, the remainder of their work in progress inventories will probablyremain 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 completingtheir 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 usedby 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 companys 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 AircraftCorporation. 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 onthis order, the company will be due nothing on these shipments until their $1,566,000 credit with Hampton isexhausted.

Hamptons assuming accruals will remain about the same on August31, and their monthly outlay for all expenses other than interest andraw materials purchases should be around $400,000 per month.Due to poor economic conditions and the companys desire toconserve cash; they have spent little on new equipment in the lastseveral years, 1979. This has contributed somewhat to thedifficulties they have had in maintaining production at full capacitythis year. As a result, Hampton has requested an additional$350,000 loan at an interest rate of 1.5% monthly, with promise ofrepayment at the end of December, 1979. This loan is necessary to purchase certain needed equipment tomaintain the production. The tax people estimated the equipment will qualify for a 10% investment tax credit. Thecompany is scheduled to pay $181,000 in taxes on September 15 and December 15. Also, Mr. Cowins hassuggested 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 newloan from the St. Louis National Bank. By following Mr. Cowins plan, the company will be short $332,000 (Exhibit1) in December. Hampton, a profitable firm, has fallen behind on their orders, and Mr. Cowins recommends thatthey need more financing to purchase certain needed equipment. Hampton has notified the St. Louis NationalBank that they will not be able to repay in September. Also, they have requested an extension. For the past monthor more, Hampton has been operating at full capacity, and with additional back orders, which has put them behindin their shipment of orders. In addition, their shipment schedule has been upset because they have been waitingfor electronic control mechanisms from their suppliers. The falling behind has also caused them to have less thanwhat is needed for accounts receivables turnover.

The cash budgets and statement of sources and uses yield negative results concerning the principal payment ofthe loan for December (Exhibit 1), based on Mr. Cowins plan. This analysis is based on projected sales, dividendpayments and tax payments. Consequently, the sales projects and accounts receivables are 30 days net; if notpaid 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, butHampton 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 outstandingcommon stock, because it had decreased sufficiently in value. Although they had good intentions to increase thecompanys stock value, their finances have suffered because of the repurchase. Mr. Cowins offer to pay $150,000in dividends in December is not reasonable, because Hamptons finances will suffer, causing them to havenegative cash flows. (Exhibit 1)

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 loanrepayment one month until January allows for account receivables of December to become collected, because ofthe company collection policy of 30 days net. This means Hampton will not have to go into the negative to pay theloan 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 inDecember, 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 theloan, and cancel the dividend payment to make the company more profitable. Also, this would strengthenHamptons 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, shouldreject 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 repaythe original loan in December without even considering the requested loan. However, with the proper financialadjustments, both loans can be fully repaid by January. For relationship reasons, Mr. Eckwood may want to grantthe loan, as long as the terms are reworked to help guarantee, that the bank will get paid. The extension of theloan and cancelation dividends will leave Hampton in a manageable situation, allowing them to continue to be aprofitable 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 nearfuture 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 theyhave forecast.

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