Butler Lumber case study
Why does BAL need to borrow money to support its profitable business? Draw up a Fund Flow Statement, I. E.
, Funding and Uses a. Funding would include Bank Borrowing, Trade Credit, Retained Earnings, Cash, Accrued Expenses b. Uses would include Inventories, AIR, Buyout, Reduction in debt, increase in fixed assets/accounts Response: BAL needs to borrow money from the bank to take benefit of the purchase discounts.
During the last two years, BAL had taken very few purchase discounts cause of the shortage of funds arising from his purchase of Starks interest in the business and other additional investments. If Butler is able to borrow at a rate lower than the one he will be losing by not taking the purchase discount, he should borrow from the bank. The company is anticipating substantial increase in sales over 1990-1991.
If he is able to pay the money faster, he will not be able to take the trade discounts, but also decrease the company’s account payable. . Will the bank credit of $465,000 be sufficient to fully meet the company’s acquirement at least over the next year? Why or why not? What does it depend on? Response: Without changing anything in the spreadsheet, BAL needs to borrow $KICK from the bank. Therefore $KICK from Northrop National Bank will be sufficient to fully meet the company’s requirement. However, this implies that BAL takes around 48 days to pay its bills and thus not able to take the purchase discounts.
The bank borrowing depends on how many days BAL takes to pay off its account. If it pays off in 10 days, BAL needs to borrow $KICK (which can still be covered by the loan from Northrop Financial). However if BAL decides to pay off in 6 days, his bank borrowing increases to $KICK, which will be more than $KICK that the bank is borrowing BAL. But he doesn’t get any special discount by paying it in 6 days instead of 10 days; he will get the same 2% trade discount.
Thus, I think $KICK is sufficient to meet his requirements over the next year.
3. How attractive is it for BAL to take the trade discount? How much do you really save from taking advantage of it per year? Response: The trade discount is attractive for AL. In 1990, BAL paid the bill in (((Accrued Expense + Accounts Payable)/CSS)*365) = 55. 22 days. BY not using the discount, BAL paying 16.
14% interest rate. BAL is paying a 16. 4% interest rate per year by not using the discount of 2% for payment made within 10 days. Since the interest from the loan from Northrop Financial will be set on a floating-rate basis at 2% points above the prime rate (Dodger indicated that the initial rate will be around 10. 5%), BAL Nil be paying an interest rate of 10.
5%. Thus his bank interest rate is lower than the Interest rate he is paying by not taking the discount. Thus, the trade discount is really attractive for BAL.