Swan-Davis, Inc. Case

Introduction

Swan- Davis, Inc. (SDI) is a public company that manufactures equipment for sale to large contractors. Stock currently sells for $15. Tom Stone, founder and current chairman, owns 14% of the stock. Stone, officers and directors own 27% of the shares as a group. Due to the highly competitive and cyclical industry, SDI has been experiencing many problems. Due to low profit margins, the company is in violation of loan covenants with their bank. SDI’s current ratio is 1.6, below the required 1.75. Also, their Times-Interest-Earned ratio is 3.4, below the required 3.5. If the violations are not corrected, the company will be forced to file for Bankruptcy. However, Vice President and Loan officer, Isabelle Ramirez, agreed to hold off taking any action as long as the company can supply the bank with a specific, feasible, and credible plan for getting SDI out of its difficulties. Filing for Bankruptcy hurts every party involved, including the bank, so Ramirez is willing to give SDI the opportunity to get back on track.

The construction slump of 1995 led to a drastic decrease in demand. SDI reduced its prices in hopes of stimulating sales but the price cut fell short to expectations. Sales and profits remained low and inventories increased dramatically. Also, SDI relaxed credit standards and lengthened its credit terms but this only led to unstable cash flows. However, Tom Stone remained optimistic and made the decision to keep investing in plant and equipment. Accounts payable also increased rapidly because the methods SDI had been using to raise capital were falling short. It is important to mention that SDI had recently signed a $20 million loan contract for expansion purposes that will take place during the second quarter of 1997. Taking all this consideration, SDI’s treasurer, Bob Wilkes strongly believes that they can turn the company around with a few changes.

Answers to questions

1. Apply the DuPont equation (ROE = Profit margin x Total assets turnover x Equity multiplier) so SDI’s data to obtain a general overview of the firm’s financial condition. Consider SDI relative to its industry, its historical trend, and its forecasted trend.

According to its ROE of 7.6% ( ROE = 2.6 x 1.0 x 2.9 = 7.6%) relative to the industry ROE of 15.6%, the company is in poor condition. However, the forecast trend shows that the firm’s ROE should increase to 16.0% by 1997.

a. What areas of strength, what weaknesses, and what needed corrective actions are revealed by the historical data?

A strength that the historical data reveals is that SDI’s recent past performance has been better than the industry. For instance, ROE for 1994 was 21.3% compared to the industry with an ROE of 14.2%. This quick comparison signals that SDI has potential for growth and it was giving its shareholders more for their