Pop's Recycling Company

In April 1991, the owner and manager of Pop's Recycling Company, J. R. Vann, approached the Crewe National Bank (CNB) concerning a loan. This visit to the bank was the second for Vann in the last eighteen months. An unusual occurrence, he thought, for a highly profitable firm. The company (a recycler of metal, glass, and paper) was in the midst of a healthy increase in sales. Operations were begun in 1980, and the firm had shown a profit each year since 1982.

The company was founded in 1980 by J. R. Vann in response to the growing usage of recycled material in the manufacture of paper products, as well as metal and glass products. The primary raw material was scrap, which was hauled in by scrap collectors of various sizes. While paper and glass were recycled by the company, the business consisted mainly of the processing of scrap metal.

There had been considerable consolidation in the metal recycling business during the past decade. In fact, J. R. Vann, known as Pop to nearly everyone, started Pop's Recycling Company against the advice of certain business associates. Their primary concern was the apparent falloff in the availability of scrap metal. As a result of that trend, some of the small brokers or recycling yards had either gone out of business or had been bought by larger recycling yards such as Pop's. That meant the larger, more well-established yards were getting r stronger, which in turn meant that a new entrant into the business faced an uphill climb. J. R. Vann, however, was convinced that he could make a strong showing in the business. He had become familiar with the business, over the years, through prior employment in the steel industry. As a result of that conviction, his entire savings and a sizable loan from a local insurance company launched Pop's Recycling Company.

The processing of the steel taken in from its "across the scale" purchase of scrap metal consisted of shredding or shearing the metal. Shredding was used to process such metal as junk cars, the primary source of scrap and shearing was used to process steel bars and other structural type steel. The company took in approximately 30,000 tons of metal which required shredding and about 15,000 tons of metal which needed to be shared.

The processed metal was shipped to foundries across the United States for use in a variety of applications. In fact, the company was such an important supplier of metal to specific foundries, it had become necessary to keep a certain level of inventory on hand in order to ensure that the demand could be met without delay. The sales forecast for Pop's for 1992 was$14,500,000.

The recycling companies which had survived the "shake-out" of the 1980s, as it had become known throughout the economy, meant to stay very loyal and dependable relative to their customer base. Accordingly, a good relationship with the foundries was a must. At the level of Pop's, this meant keeping a steady supply of scrap metal throughout the year. That goal created a need for cash. Further, machinery had to be kept in good working order, and suppliers expected to be paid within the 30-day limit, which had become standard in the business. Of the approximately sixty competitors on the east coast of the United States, twenty were in the mid-Atlantic region and considered direct competitors of Pop's. Thus, a well-managed balance sheet was essential. In that regard, industry averages for certain items are shown as Table 3. Of special concern were the company's payables and inventory levels. Mr. Vann believed that a reasonable level in these areas would permit him to maintain a solid relationship with his suppliers and his customers. Vann believed that his long-term debt would be constant, that is, would remain at its present level. In addition, he hoped to move the profit nearer to the industry average level, or beyond.

The loan which Mr. Vann sought from CNB was for the purpose of increasing the company's stock of scrap metal. In recent months, a large portion of railroad track and rolling stock was being dismantled at certain points in the immediate region, and an unusually large supply of steel had become available. These "bulges" in the incoming supply of scrap metal were a typical occurrence. It provided the recycling companies an opportunity to build up their backlog of steel and other metals. Such a supply would be used to feed the emerging and successful new, smaller steel companies in the United States. (The cold-roll production process used by foundries had given some hope to the once flagging steel industry).

In order to properly manage the situation, Vann considered a loan of $200,000 to be adequate for his short-term needs. The financial statements which follow illustrate certain aspects of the company's operating history.

The bank's loan officer, Cheryl Fries, wanted to make the correct and appropriate decision. Pop's Recycling had a long-standing reputation as a well-run company. In addition, her informal grapevine indicated that Vann handled his credits well. If the analysis of the company's financial statements bore out these impressions, the bank would have gained another solid commercial customer. The essential questions which Fries wanted to answer related to the necessity of the loan, the size of the loan, and if it were actually needed. She began an analysis of the company's needs based upon their audited financial statements shown as Tables 1 and 2, and competitor information in Table 3 (next page)

Questions on Pops Recycling Company case:

1.Please analyze the financial condition of the company; under the following categories, and evaluate it:

-profitability

-asset utilization/activity

-debt management

-liquidity

2. Calculate the External Funds Required (EFR) for the Company, to achieve the projected sales.

3. Project, for the year 1992, sales, inventory, accounts receivable, fixed assets, accounts payable, accrued wages and taxes, and retained earnings, using ALL the information provided in the case (including assertions by the management). Compile a proforma balance sheet for 1992, with cash/Notes Payable as the balancing figure. Why is the Notes Payable in this answer different from the AFN in #3 above?

4. If the bank decided to require the company to maintain a current ratio of 2.0 as acondition of its loan, how will the projected balance sheet for 1992 change? Please construct the new projected balance sheet, clearly indicating the changes.

5. What are the specific options available to the company for meeting its need for additional funds if

(i) the bank provided a loan of $200,000 as sought by the company

(ii) the bank declined the loan request

Please justify your selected options, clearly indicate and quantify them, and construct the proforma balance sheet for both situations.

TABLE 1 Pop's Reeyeling Company Income Statement Data 1987 1988 1989 58,200,000 58.700,000 $9,500,000 $410,000 440,000 332,000 Sales Profit after tax 1990 SI 1,000,000 330,000 1991 $12,000,000 336,000 Case 5 Pop's Recycling Company TABLE 2 1990 1991 Cash Accounts receivable Inventory Total current Assets Fixed assets, net Total assets Pop's Recycling Company Balance Shee! 1987 1988 1989 $290,100 $239.266 $229,500 418,200 489,070 $32,950 964.500 1.121.036 1482.525 $1,672,800 $1,898,272 $2251,975 2.569.200 2,786,061 3.150.513 84.182.000 $1,684,133 $5,402.488 $385,020 $408.476 $647,869 510,480 541,098 581,400 150.000 78.000 75.000 $1,045,500 $1,027,574 $1,304.269 5585,480 665,839 775,200 1,020,408 1.020,408 1,020,408 1.530,612 1.970.612 2.302.611 $4.182,000 84.684.433 55.402.488 3215,500 425,000 2.598,693 $3,239,193 3.138,540 56.377,723 S205,100 634,742 3.220.087 84,059,929 3452.383 $7,512,312 Accounts payable Acerued wages and taxes Notes payable bank Total current liabilities Long-term debt Owners' equity Eamed surplus Total libilities and equity 51,140,650 610,470 75.000 $1,826,120 775,200 1.143,801 2.632.612 46,377.733 $1,550,175 673,130 75.000 $2,298,305 1,101,600 1,143,795 2.968612 $2.512312 TABLE 3 Pop's Reeyeling Company Selected Operating Data for Mafor Recyclers, 1991 Profit margin on sales Total debt-to-total assets Inventory-to-sales Accounts payable as a percent of sales Current ratio 5 Percent 25 Percent 28 Percent 10 Percent 1.80:1 TABLE 1 Pop's Reeyeling Company Income Statement Data 1987 1988 1989 58,200,000 58.700,000 $9,500,000 $410,000 440,000 332,000 Sales Profit after tax 1990 SI 1,000,000 330,000 1991 $12,000,000 336,000 Case 5 Pop's Recycling Company TABLE 2 1990 1991 Cash Accounts receivable Inventory Total current Assets Fixed assets, net Total assets Pop's Recycling Company Balance Shee! 1987 1988 1989 $290,100 $239.266 $229,500 418,200 489,070 $32,950 964.500 1.121.036 1482.525 $1,672,800 $1,898,272 $2251,975 2.569.200 2,786,061 3.150.513 84.182.000 $1,684,133 $5,402.488 $385,020 $408.476 $647,869 510,480 541,098 581,400 150.000 78.000 75.000 $1,045,500 $1,027,574 $1,304.269 5585,480 665,839 775,200 1,020,408 1.020,408 1,020,408 1.530,612 1.970.612 2.302.611 $4.182,000 84.684.433 55.402.488 3215,500 425,000 2.598,693 $3,239,193 3.138,540 56.377,723 S205,100 634,742 3.220.087 84,059,929 3452.383 $7,512,312 Accounts payable Acerued wages and taxes Notes payable bank Total current liabilities Long-term debt Owners' equity Eamed surplus Total libilities and equity 51,140,650 610,470 75.000 $1,826,120 775,200 1.143,801 2.632.612 46,377.733 $1,550,175 673,130 75.000 $2,298,305 1,101,600 1,143,795 2.968612 $2.512312 TABLE 3 Pop's Reeyeling Company Selected Operating Data for Mafor Recyclers, 1991 Profit margin on sales Total debt-to-total assets Inventory-to-sales Accounts payable as a percent of sales Current ratio 5 Percent 25 Percent 28 Percent 10 Percent 1.80:1