Sharon Vincent is the current general manager of Helping Hand, and she recently received a letter from the present owner, Justin Stafford. Stafford is best described as a passive stockholder who pretty much leaves the operation of the firm to Vincent. From time to time, however, he is fond of bringing in consultants in order to evaluate the companys performance and to help Stafford developed pointed questions to ask management. Apparently as a result of a recent but not exhaustive study by one of these consultants, Stafford has raised a number of issues that he wants addressed. The three most important issues center on the firms return on equity (ROE), debt policy, and what Stafford calls a logical inconsistency in Helping Hands 1995 financial statements. In the letter, dated February 9, 1996, Stafford wrote Vincent that he was troubled by our consistently low ROE and urged Vincent to seek ways to bring this ratio at least up to industry standards. At the same time, he encouraged Vincent to minimize the firms use of debt. Stafford notes that the sales of Helping Hand are quite sensitive to economic downturns, and he believes that the company will face intense competition from nationwide chains like Lowes. Consequently he worries about our ability to repay what we borrow, especially during a recession. Though he is aware that the company is not highly leveraged relative to industry standards, Stafford recommended that Vincent strongly consider (1) retiring all long-term debt as quickly as possible and (2) increasing the firms liquidity position. Actually, Vincent is quite surprised at these two suggestions. Stafford is something of a high roller and he spends much of his time racing automobiles and playing bridge and poker for large stakes. Thus, Vincent is a bit amused at Staffords apparent fear of financial distress, given the chances he takes driving fast cars and his willingness to risk thousands of dollars on a single hand of poker. Still, she thinks that his points are well worth considering. Stafford is also perplexed by Helping Hands need for funds during 1995 and worries that the firm may be chewing up cash unnecessarily. He notes that 1996 was highly profitable and yet he was asked to contribute %407,000 to support the companys operation. It seems illogical, Stafford wrote, for a profitable firm to have such a need for cash. THE REACTION As Vincent reflects on Staffords letter, she decides that it is wise to develop a forecast for the coming year to see if any external funds will be needed. She realizes that part of the problem from Staffords point of view is that he was unexpectedly if not inappropriately asked to contribute capital in 1995. It is a good idea, therefore, to alert Stafford as soon as possible to any potential cash shortfall in 1996. She estimates that sales in 1996 will total $24,707,000, a forecast that assumes no change in the firms credit policy. About 15 months ago she decided that the companys credit terms and standards were downright stingy and certainly more conservative that those of the competition especially the nationwide chains. It became quite clear that Helping Hand had to loosen its credit policy in order to remain competitive. An absolutely essential defensive move, she argued at the time. The firm presently offers credit terms of 2/10, net 30 to qualified buyers. That is, Helping Hand offers a 2% discount to customers who pay within 10 days, and customer who pass up the discount are expected to pay in full within 30 days. Assuming no change in credit standards, Vincent expect that 60% of all sales will be on credit. She estimates that 50% of all credit sales will be paid on the tenth day, 40% on day 30, and 10% will pay late on day 40. Vincent also thinks that inventory control can be tightened. She intends to purge slow-moving items and use purveyors with relatively short delivery times. These changes should increase inventory turnover, and she expects that cost of goods sold divided by inventory will rise to 3. Vincents forecast of accounts payable needs to consider the easier credit terms offered by many suppliers. Two years ago about 80% of the firms purchases were on terms of net 30. That is, most suppliers offered no discount, and payment-in-full was expected by day 30. The remaining 20% were on terms of 2/10, net 30. Increased competition among hardware and lumber suppliers has resulted in more attractive credit terms. During the last year about half of Helping Hands purchase were made on terms of 2/10, net 30. Vincent expects this to rise to 75% in 1996 with the remaining 25% on terms of net 30. After she completes the 1996 forecast, Vincent intends to respond to Staffords ROE and debt concerns. Her initial reaction, though, is that Stafford is much too cautious on the issue of debt financing. In fact, she really thinks that the firm is underleveraged and should increase its debt ratio to industry standards. She realizes, however, that such an increase is simply out of the question unless Staffords position softens considerably. As Vincent rereads Staffords letter she is struck by the though that two perfectly sane and intelligent people can look at the same number, understand completely where it comes from, and yet disagree entirely on the whether the number is good or bad. There is, of course, her difference with Stafford regarding the firms debt ratio. And in the same letter Stafford also noted that the firms current ratio (Current Assets/Current Liabilities) looked suspiciously high. Yet a few weeks ago, the firms banker complimented Vincent on Helping Hands extremely solid working capital position.

Answer the ff:

Construct Helping Hands 1995 sources and uses statement [no-dividends were paid in 1996 and capital spending was 165.1 (000)

Why did Helping Hand have a need for outside capital in 1995?

Does it appear that the firms need for outside capital in 1995 was to be expected, or does it appear that this need for cash was the result of suspect managerial practices? Use information in the case and any other financial statistics you think are appropriate to answer this question.

The owner, Justin Stafford, is disturbed by the firms consistently low return on equity (ROE). At the same time, he is reluctant to use much debt. Use the Dupont system to see if these views are complementary or competing. Defend your choice.

Vincent does not believe that Helping Hand is overleveraged at present. Part of her argument involves calculation of the firms debt, times interest earned (TIE) and fixed charge coverage (FCC) ratios. Explain why a firms debt ratio other relevant factors the same will be overstated during a period of rising interest rates if it is calculated from information on the balance sheet. (Hint: consider the difference between book value and market value)

Construct Helping Hands 1995 sources and uses statement [no-dividends were paid in 1996 and capital spending was 165.1 (000)]

Why did Helping Hand have a need for outside capital in 1995?

Does it appear that the firms need for outside capital in 1995 was to be expected, or does it appear that this need for cash was the result of suspect managerial practices? Use information in the case and any other financial statistics you think are appropriate to answer this question.

The owner, Justin Stafford, is disturbed by the firms consistently low return on equity (ROE). At the same time, he is reluctant to use much debt. Use the Dupont system to see if these views are complementary or competing. Defend your choice.

Vincent does not believe that Helping Hand is overleveraged at present. Part of her argument involves calculation of the firms debt, times interest earned (TIE) and fixed charge coverage (FCC) ratios. Explain why a firms debt ratio other relevant factors the same will be overstated during a period of rising interest rates if it is calculated from information on the balance sheet. (Hint: consider the difference between book value and market value)

Vincent expects that 60% of all 1996 sales will be on credit with terms of 2/10, net 30. She estimates that 50% of these credit sales will be paid on the 10^th day, 40% on day 30 and 10% will pay late on day 40.

What will be the firms 1996 average collection period on its credit sales?

Predict the 1996 level of receivables assuming sales of $24,707 (000)

In part due to price discounts from suppliers, cost of goods sold is expected to be 65% of sales in 1996. Purchases are predicted to equal 70% of CGS. 75% of these purchases will be made on terms of 2/10, net 30, and Vincent fully intends to take the discount and pay on day 10. The remaining 25% will be made on terms of net 30.

If offered credit terms of 2/10, net 30, Vincent thinks it is a good idea to take the discount. Do you agree? Explain.

Is it reasonable to think, as Vincent does, that using suppliers with shorter delivery time will increase inventory turnover? Explain

Vincent observed in the case that two perfectly sane and intelligent people can look at the same number, understand completely where it comes from, and yet disagree entirely on whether the number is good or bad.

Explain why the banker thought Helping Hands current ratio was impressive, while Stafford was decidedly unimpressed.

Consider the reactions of two individuals to the rising average collection period of their firm. The sales manager is quite pleased at the increase while the credit manager is quite concerned. Explain these different reactions.

Consider two stockholders who have identical subjective probability distribution about the future earning prospects of the company. That is, they both feel the same way about the firms probable earnings. Yet one stockholder favors using additional debt financing while the other thinks that using more debt is simply too risky. Explain why this disagreement has occurred.