Corporate Finance
Clarkson Lumber Co – Part 1
Read the Clarkson Lumber Company case. To help you organize your thoughts for the case discussion during class, attempt the assignment below. (Hint: do not focus on the decision to form. a new banking relationship, instead focus on the assignment questions, largely based on the exhibits instead of the text.)
There are a lot of questions, some possibly a little difficult. Try to do as much as you can. In class, we will go over all the questions step-by-step, but it’s important you attempt all questions to understand the solutions.
You do not need to submit a solution to this case.
Questions 1-2 of this assignment are intended review the concept of Free Cash Flows (FCF) using historical information. Questions 3-7 are step-by-step calculations to project FCF in 1996.
Assignment
1. Generate the Statement of Cash Flows for Clarkson for the year ending in 1994.
Notes: We have not done this in class, but you should know how to construct this statement from your accounting class. Below, you will find a worksheet to help you. Hint: During 1994, Mr. Clarkson bought Mr. Holtz’s interest in the firm. This transaction increases debt by $200 (see total notes payable to Mr. Holtz) and decreases net worth by $200 (share repurchase).
2. Compute the free cash flows for the same year.
Notes: To compute the taxes, use the tax rate information in note (c) to Exhibit 1.
3. For questions 4 to 6, we will need some key financial ratios. Compute the following ratios for 93, 94, 95 and their average for the period.
• Income Statement
i. COGS/Sales
ii. Operating expenses/Sales
• Balance Sheet
i. Net Fixes Assets Turnover (NFATO) = Sales/netPPE
ii. Accounts Receivable Days on Hand (AR DOH) =AR/(Sales/365)
iii. Inventory Days on Hand =Inventory/(COGS/365)
iv. Accrued Expenses/Sales
4. Suppose that sales in 1996 are $5.5 million. Project NOP. Assume:
• This is an “average” year compared to 93-95. This implies, for example, that you should project COGS so that the COGS/Sales ratio in 1996 equals the average of this ratio in the 93-95 period. Question 3 lists the key financial ratios you can use.
• Taxes are given by the schedule described in note (c) to Exhibit 1.
• Clarkson does not get any trade discounts.
5. Project netPPE and the change in netPPE.
6. Project the change in NWC.
• For accounts receivables, inventory, and accrued expenses assume that
1996 is an average year and use relevant ratios in question 3.
• To project, accounts payable assume that accounts payable days on hand in 1996 is 45 (AP DOH =AP/(Purchases/365)).
• Hint: You will need to estimate what purchases will be in 1996.
Remember that Inv(t) = Inv(t-1) + Purchases(t) – COGS(t). So you should have projected enough information already to back out what purchases will be for 1996.
• All of the “Notes payable” on Clarkson’s balance sheet are interest bearing liabilities.
7. Using your answers from questions 4, 5, and 6, project the FCF in 1996.
Discussion Questions
1. How does cash flows from operating, investing and financing activities relate to the FCF?
2. For many of our projections we multiply a ratio by sales. What are we assuming about the production function?
Worksheet for Question 1: Net Change in Cash Operating Activities*
NI
- Increase in Accounts Receivable
- Increase in Inventory
+ Increase in Accounts Payable
+ Increase in Accrued Expenses
CF from operating activities
Investing Activities
- Increase in PPE
CF from investing activities
Financing Activities
+ Increase in debt outstanding
- Stock repurchased
CF from financing activities
Net change in cash
*Typically we add back depreciation as part of the adjustments to net income in the operating activities section. In this worksheet, we are adding back depreciation when computing the increase in net fixed assets in the investing activities section.