Butler Lumber Company

Why does Mr. Butler have to borrow so much money to support this profitable business?

There are mainly two reasons. One is that its rapid expanding during past years. From 1988 to 1991 (estimated), the revenue growth rate is around 30% per annum. Meanwhile, Butler Lumber Company’s inventory and accounts receivable have also soared. If bank and trade note payable are excluded from balance sheet, the company’s net working capital has also increased exponentially. Its business model requires the company to rely heavily on short-term financing. On the other hand, Mr. Butler bought out Stark’s interest for $105,000, which was partly financed by a loan of $70,000 with annual installment payment of $7,000. Unfortunately, the maximum loan that Suburban National Bank agreed to make is $250,000. In 1991, Butler Lumber borrowed 247,000, which was close to the upper limit. In conclusion, though the business is profitable, he needed to borrow substantially to support expansion and meet interest/installment payments. In another word, it is a “question mark” requiring consistent investment according to BCG-matrix.

Do you agree with his estimate of the company’s loan requirements? How much will he need to borrow to finance his expected expansion in sales (assume a 1991 sales volume of $3.6 million)?

Yes, we do agree with the company’s loan estimate. Assume the revenue of 1991 is $3.6 million. At least $419,000 is needed to finance his expansion plan. Ideally, he will borrow more than that figure, like $465,000, to have some flexibility to meet better-than-expected scenario. Common size income statement and balance sheet are developed in the Appendix A.

Net sales of 1991 is assumed to be $3.6 million, and percentage of COGS, and operating expense to sales are expected to stay in line of past three years’ trend. Interest expense is consisting of two components, 11% interest rate