Case Link Question (1) Directions: Click the "Case-link" displayed above and use the information provided in Hearth and Home, Parts A and B, to answer this question: Given Hearth and Home's historical performance, which of the following describes a reasonable downside projection scenario for Hearth and Home? O Sales will decrease five to ten percent Sales will increase only five to ten percent O Sales will increase twenty to twenty-five percent O Sales will decrease twenty to twenty-five percent Hearth and Home Part A Company Information Hearth and Home sells, installs, and services residential fireplaces. Formed 22 years ago by Len Wilkinson as a retailer of fireplaces and accessories, the company installed virtually all of the fireplaces it sold and guaranteed its work for 10 years. The company built a reputation for prompt, quality workmanship and gradually, starting six years ago, several of the area's leading contractors began to subcontract chimney and fireplace installation to Hearth and Home During its early years, most of the company's sales took place from October to March. As it expanded, subcontracting sales occurred throughout the year, though slightly more in the summer months. Sales are now fairly evenly divided between retail and subcontracting The Wilkinsons have financed the company with long-term debt. The family has provided term loans totaling $350,000, and your organization has provided $200,000 in long-term debt. Your organization also made available to the company what is now a $400,000 revolving credit. H and H may bort up to 50 percent of receivables outstanding for less than 60 days and up to 40 percent of inventory, excluding inventory work in process. The company must be out of debt for 30 consecutive days during the second quarter of every calendar year. Until the end of 20Y3, the company was a model customer, meeting the second-quarter 30-day clean-up requirement fairly easily in 2011 and 2072. At the end of fiscal 2013, however, the company was unable to clean up the line. In fact, at the end of June, the outstanding balance was $101,000, the company having been unable to reduce the line significantly below $100,000 at any time during the entire second quarter. The balance outstanding on the last day for which you have data was $153,000 John Holmgren is the lender responsible for the relationship, and he has asked you for assistance in deciding how to handle the loan. When the company could not meet the cleanup requirement, John waived the requirement based on the company's past history and performance. In John's opinion, H and H's management has such high integrity that your organization will be able to recover its money, he believes that the owners would sell their houses if necessary to repay the debt. Having said that, John is also aware that the owning family depends upon dividend income and considers an annual dividend of at least $80,000 to be mandatory John is feeling the dissatisfaction of credit management, which is unhappy with his decision to waive the clean-up. He needs to come up with a solution to the problem that will meet both the company's and your organization's needs. As you and John discuss the situation, he tells you that H and H's management expects sales to increase significantly in 20Y4 and that part of that increase will be due to additional contracting - mainly repairing older installations by a couple of competitors that have since gone out of business. The Wilkinsons have proposed that the limit on the revolving credit be increased to $500,000 Hearth and Home Part B Hearth and Home Balance Sheets (in $000s) As At June 30 20Y3 20Y2 20Y1 2071 ASSETS Current assets Cash $ 66 $ 123 $ 100 Accounts receivable 376 303 240 547 461 417 Inventory Other current assets 107 70 117 Total current assets 1,096 957 874 Fixed assets 313 257 245 Trademarks and goodwill 107 71 71 TOTAL ASSETS $ 1,516 $ 1,285 $ 1,190 LIABILITIES AND OWNERS' EQUITY Current liabilities $ 67 $ 67 $ 67 101 5 0 Current portion-LTD Notes payable Accounts payable Accrued expenses 244 204 148 69 64 57 Other current liabilities 46 28 47 Total current liabilities 527 368 319 Long-term debt 330 397 464 Other noncurrent liabilities 20 19 18 Owners' equity 639 501 389 TOTAL LIABILITIES AND OWNERS' EQUITY 1,516 $ 1,285 $ 1,190 Working investment $ 610 $ 496 $ 452 Hearth and Home Part B Hearth and Home Income Statements (in $000s) Years Ended June 30: 20Y3 20Y2 20Y1 Sales $ 3,570 $ 3,000 $ 2,500 2,467 2.093 1,773 Cost of goods sold Gross profit 1,103 907 727 36 33 36 Interest expense Depreciation expense Operating expense 60 52 50 586 477 371 Profit before taxes 421 345 270 Taxes 188 149 108 Net profit after taxes $ 233 $ 196 $ 162 Dividends 95 84 65 Earnings retained $ 138 $ 112 97