Corporate Finance Padgett Paper Company Case Study

Padgett Paper Products Company

Question 1.

Industry Analysis

Padgett Paper, a publicly traded OTC company, sells stationary products such as notebooks and filler paper.

a) High Cost of Materials - The paper industry relied on raw material prices like paper, which rose to more than 50% since 1994.

b) Lower Profit Margins - With the increase in costs, smaller companies were not able to sustain their profit margins. These small companies were bought out or became "public" in the market.

c) Lucrative Market - With the booming market, companies traded at higher share prices which increased the P/E multiples.

Firm Policies Analysis

The Company sold primarily to retailers and wholesalers in the United States and Canada.

a) 2/10 net 30 - Customers were required to pay within 30 days of buying goods. They were given a 2% discount if payment was received within 10 days. Customers generally stretched their payments to 60 days.

b) Cost Structure - Padgett followed the FIFO costing structure until 1996 when they switched to LIFO. This resulted in paying fewer taxes on their earnings, which in turn increased their net income.

c) Borrowing Pattern - There was a seasonal pattern of approximately $2 million in borrowings and the peak occurred in the summer months.

Financial Performance Analysis

1) Profitability

Padgett has a steady sales growth from 1993 to 1996. They maintained gross profit margins of approximately 39%, which resulted from their operational capabilities. Their return on equity (ROE) increased from 11% to 14%, proving the company has shown higher profitability regarding investments by its shareholders. Padgett is a function of profit margins, risk and turnover. High profit margins are evidence of this.

2) Asset Efficiency

a) DOI = (365*Inventory)/COGS = 176 days for 1994, 182 days for 1995 and 213.5 days for 1996. Operating efficiency is trending downward with an increase in DOI.

b) DOR = (365*A/R)/Sales = 74.3 days in 1994, 62.8 days in 1995 and 68.5 days in 1996. There is a downward trend with respect to collections illustrating that collecting efficiency is good.

c) DOP = (365*A/P)/COGS = 36.75 days in 1994, 36 days in 1995, 29 days in 1996. Though the company is not saving much on cash by paying quickly, it maintains a healthy relationship with its suppliers.

3) Leverage

Leverage = Debt/Equity. It remains at 2.5 from 1993 to 1996. This is not very high and does not