Capital Financial

Capital Financial is a privately held lender that specializes in business loans. They have enjoyed great success historically. However, they have been on an incredible run recently as they have had twenty-four consecutive months without a missed payment for their entire book of business. Their loans are generally between $25,000 and $100,000. Considering their recent success and their desire to go public, the CFO has decided to seek clients with bigger business needs. This strategy can yield greater rewards, but it is accompanied by greater risk. The CFO got her wish and landed YGC Inc. as a client, a publicly traded store that needed $1,000,000 in capital to open a new location. The Capital Financial analysts were impressed with the firm's level of profitability. Their impressive financial performance correlated with a stock price on the incline. Capital Financial issued favorable credit terms to YGC Inc. for $1,000,000 which is ten times the amount they normally issue loans for.

 

A secondary audit by Capital Financial has revealed that the initial analysis did not sufficiently analyze all of YGC's financial statements. While YGC is extremely profitable, they are also highly leveraged. The CFO was furious when he learned of this.

  

2. Explain why loaning to a profitable, yet highly leveraged firm like YGC can be a risk for Capital Financial. Identify the type of risk.
4. How can the risk be mitigated at this point? Describe the steps Capital Financial can take at this point to reduce their risk exposure.