Hampton Machine Tool Company

9-280-103 Rev. 12/3/91

SUGGESTED ANSWERS
Rocky Higgins
April 2001

a)

Prepare a sources and uses of cash statement for Hampton for the period November 30
August 31, 1979.
Sources and Uses of Cash November 30, 1978 August 31, 1979
SOURCES
Increase in bank debt

$1,000

Increase in retained earnings

883

Decrease in cash

961

Increase in customer advances

726

Increase in accounts payable

600

Decrease in accounts receivable

561

Increase in taxes payable

329

Decrease in net fixed assets

92

Decrease in prepaid expenses

20

TOTAL SOURCES OF CASH

$5,172

USES
Stock repurchase
Increase in inventories
Decrease in accruals
TOTAL USES OF CASH

$3,000
2,163
9
$5,172

b) Reflecting on this sources and uses statement, why do you think this profitable company
cannot repay its loan on time? What developments between November and August have
contributed to this situation?
Judging from the sources and uses statement it appears that the sharp increase in inventories is
responsible for the companys inability to repay its loan. This increase in inventories appears
due to unexpected delay in receiving a critical part.

c)

Based on the information in the case, prepare a projected cash budget for the four months,
September through December 1979.
Projected Cash Budget September 1979 through December 1979.

Receipts
Collection of receivables*

September

October

November

December

$684

$1,323

$779

$1,604

Bank loan

350

Total cash receipts

$684

$1,673

$779

$1,604

$948

$6009

$600

$600

Other operating outlays

400

400

400

400

Tax payments

181

Disbursements
Payment of accounts payable**

Interest payments bank loan

181

15

15

20

Principal payments bank loan

20
1,350

Dividend payments

150

Total disbursements

$1,544

$1,365

$1,020

$2,701

Beginning cash balance

$1,559

$699

$1,007

$766

Net cash receipts (disbursements)

(860)

308

(241)

(1,097)

Ending cash balance

$699

$1,007

$766

$(331)

* Assumes a 30-day collection period.

** Assumes a 30-day payables period.
October collections of receivables equals $2,163 minus $840 advance payment. Similarly, the November
collections equals $1,505 minus $726 advance payment.
d) Prepare a projected income statement for the same period, and a pro forma balance sheet as of
December 31, 1979. (Your income statement need not be monthly. You can make one
covering the entire four months.)
Pro Forma Income Statement September December 1979
Sales

$7,537

Projected sales Sept. December

Cost of sales

$5,740

See below

117

See below

Other expenses
Profit before tax
Taxes
Profit after taxes
Dividends
Addition to retained earnings

$1,680

48% of profit before tax - $35 ITC

771
$909
150

Proposed Dec. dividend

$759

Notes:

Basic accounting relationship: beginning inventory + purchases + other outlays cost of sales = ending
inventory; solving for cost of sales,
Cost of sales = purchases + other outlays change in inventory
Cost of sales = $1,320 reduction in WIP inventory + $420 reduction in RM inventory + $2,400 purchases +
$1,600 other outlays
Cost of sales = $5,740.
Other expenses =$47 Depreciation + $70 4 months interest = $117.
Depreciation of new machines: $350 straight line for 8 years = $43.75 or $3.65 per month. Depreciation
for September December = 4 months on old equipment plus 2 months on new equipment = $40 + $7.
The division of expenses between cost of sales and other expenses is immaterial. What matters for this
exercise is the sum of the two.
Pro Forma Balance Sheet December 31, 1979
Cash

$(331)

Plug.

Accounts receivable

2,265

December sales.

Inventories

3,024

$4,764 - $1,320 reduction in WIP - $420 reduction in RM.

Total current assets

$4,958

Gross fixed assets

$4,300

Acc. Depreciation

3,137

Net fixed assets

Prepaid expenses
Total assets

$4,010 + $350 capital expenditure.

$3,090 + $47 depreciation.

$1,223
42

Unchanged from 8/31/79.

$6,223

Accounts payable

$600

December purchases.

Accruals

552

Unchanged from 8/31/79.

Taxes payable

888

$479 - $362 tax payments + $771 liability Sept. thru Dec.

Total current liabilities

Net worth

4,183

Total liabilities & net worth

e)

$2,040
$3,424 + $759 retained earnings Sept. thru Dec.

$6,223

Do the cash budgets and pro forma financial statements yield the same results? Why, why
not?
Hint: they should.
Further hint: If you relied on the statement on page 6, our engineering estimates indicate
that we expect to earn a profit before taxes and interest of about 23% on sales on these
shipments, they wont. Consider instead using the following accounting relation in
constructing your income statement.
Beginning inventory + purchases + other expenses cost of goods sold = ending inventory
Yes. The plug of -$331,000 equals the December ending cash balance of -$331,000.

f)

Is Mr. Cowins correct in his belief that Hampton can repay the loan in December? Does it
appear he might be able to repay the loan early next year?
Hampton appears unable to repay the loan in December. However, if you extend the cash
budget another month through January 1980, it appears the company can repay the loan early
next year.

g) What earnings is Hampton forecasting for 1979? How do these earnings compare to the size
of the bank loan? What are the companys return on assets and return on equity for 1979?
How large is the companys potential loan collateral in the form of accounts receivable?
What should Mr. Eckwood do with regard to the loan request?
Projected 1979 earnings

$1,823,000. ($914 + 909).

Projected earnings / bank loan

1.35 times (1.823 / 1.35).

1979 ROA

29% (1,823 / 6,223 using end of period assets).

1979 ROE

43.5% (1,823 / 4,183 using end of period net worth).

December accounts receivable / bank loan.

1.67 times (2,265 / 1,350).

Despite Hamptons inability to repay by year-end, this appears to be a safe loan from the
banks perspective. The loan is less than one years profits at current operations, returns are
quite high, the company has almost a full years backlog at what we are told are profitable
prices, and the company has significant collateral in the form of accounts receivable. We
might note, however, that December receivables are high. There would be less collateral in
other months.
Finally, we might note that Hampton borrowed money from the bank to meet long term needs,
stock repurchase and new equipment. It is asking a lot of a business to repay loans used for
long term purposes within a few months. The bank should not be surprised to find that
Hampton cannot repay the loans as rapidly as originally intended.
I would certainly renew and increase the loan.
h) What were the companys earnings per share in 1978? What would this number have been
using the number of shares outstanding after the share repurchase?
1978 earnings = $783,000. 1978 shares outstanding = 117,800 (11/78 balance sheet, Common
stock = $1,178,000 and par value is $10 per share.) Earnings per share = $6.65 (783 / 117.8).
After repurchase there were 42,800 shares outstanding. Ignoring any foregone income on the
$2 million of excess cash used to repurchase the shares, EPS would have been $18.29 (783 /
42.8), an impressive 3-fold increase in EPS.
Assuming the $2 million of excess cash used in the repurchase was yielding, say, 8% after tax,
earnings in 1978 would have been $623,000 ($783 - .08 X $2,000) and EPS would be $14.56
(623 / 42.8) still an impressive increase.
i)

What were dividends per share in 1978? What dividends per share does Mr. Cowins propose
paying in 1979? Do you agree with Mr. Cowins' proposal to pay a substantial dividend in
December?
DPS in 1978 were $0.42 ($50,000 / 117,800 shares).
Proposed DPS in 1979 are $5.84 ($250,000 / 42,800) an almost 14-fold increase in dividends

per share.
From the banks perspective I think this is a little rich. I would try to get him to reduce or
eliminate the December dividend.