Jackson Automotive Systems deals with the production of heating and air conditioning systems, engine cooling systems, fuel injection and transfer systems, and various other engine parts. Its primary clientele is the automotive industry in Michigan. In 2008, due to the financial crisis, Jackson cut back its production. About 5 years later, the company has gotten back on its full-operating capacity. However, it experienced some downturn in its production operation and was unable to pay its debt to the bank. The firm's president asked for an extension of time to repay its loan and to request for the approval of an additional loan. The president must come up with a presentation of the company's financial status before meeting with the loan committee.
William E. Fruhan; Wei Wang
Harvard Business Review (914505-PDF-ENG)
August 05, 2013
Case questions answered:
Case study questions answered in the first solution:
- Why does Jackson Automotive Systems need a new loan? Isn’t the company profitable? How urgent is the need for additional borrowing? Analyze Jackson’s credit & ability to pay its debt.
- Will Jackson be able to repay its loans? Perform a sensitivity analysis on the proforma statements.
- Should Jackson go ahead with the proposed dividend payout in September 2013? Should the bank agree with the payout? If yes, what seems to be an appropriate amount?”
- What terms and conditions should the bank impose to reduce the risks of the loan to the bank?
- Identify the investments (Use of funds) & the sources of funds Jackson has used over the last year or so.
Case study questions answered in the second solution:
- Why can’t a profitable company like Jackson Automotive Systems repay its loan on time? What major company developments between August 2012 and May 2013 contributed to this situation? Prepare a sources and uses of funds statement for August 2012 through May 2013.
- Why does the company need a new loan? How urgent is the need for additional borrowing?
- Prepare monthly cash budgets, pro forma income statements, and pro forma balance sheets for the last four months of the fiscal year (June-September). Do the cash budgets and pro forma financial statements yield the same results? Why or why not?
- Based on your forecasts and analysis of Jackson’s credit, is the company able to repay its loan at the end of the fiscal year? What are the risks associated with the proposed loan?
- Critically evaluate the assumptions on which your forecasts are based and perform sensitivity analysis on the fiscal year-end cash balance if sales forecasts vary from expectations.
- Should the bank extend the maturity of the current loan and approve the additional loan? Why? (To make this determination, a ratio analysis may be helpful.) If approved, what terms and conditions should the bank impose to reduce the risks of the loan to the bank?
- Why did Jackson Automotive Systems repurchase a substantial fraction of its outstanding common stocks? What is the impact of the repurchase on Jackson’s financial condition?
- Critically assess the company’s proposed dividend payout in September 2013. Should the bank agree with the payout? What seems to be an appropriate amount, if any?
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Jackson Automotive Systems Case Answers
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1. Why does Jackson Automotive Systems need a new loan? Isn’t the company profitable? How urgent is the need for additional borrowing? Analyze Jackson’s credit & ability to pay its debt.
Jackson Automotive Systems is a profitable company established in 1961 and has been a family-run company passed down from father to son. It represents the small OEM American companies that have not outsourced their production to countries like China and India.
The company has been able to meet sales capacity for the historical months of 2013, although due to the 2008 financial crisis, which hit the US, it has significantly suffered in the past. It is still facing problems repaying its loans and maintaining significant liquidity.
In September 2012, Jackson Automotive Systems, which had been primarily equity funded, took a loan to repurchase some of its outstanding stocks using 5 million in cash reserves and 5 million in short-term loans by the Michigan State Bank with a debt ratio significantly increased (D/E 0.37 as of Sept 2012) as result of this decision.
Jackson Automotive Systems is now risking insolvency and the possible failure to pay its loans and interest expenses. Spending on acquiring inventory to meet orders has increased its current assets and caused further liquidity issues for Jackson.
Other shortfalls like delays in shipment due to material shortages, a decrease in WIP by 5.04 million, and further interruptions due to Jackson needing to replace key components in its air conditioning, and they now have to perform on 90 % of annual capacity to meet the backlog of orders.
Due to the poor economic conditions due to the financial crisis, Jackson had cut equipment spending to converse cash in the previous years. This has resulted in the wearing of the equipment and the immediate need to replace the old equipment or suffer losses in operational productivity.
With backlog over of orders the previous months and Jackson needing to perform at 90 percent of its annual operational capacity, there is a current need for this loan. Otherwise, Jackson Automotive Systems will suffer a significant loss in sales and its reputation to meet its customers’ needs.
Additionally, the loan will help allow Jackson more liquidity to meet raw material purchasing needs, which are 2.44 million above the nominal amount.
An analysis of Jackson Automotive Systems’ credit and ability to pay its debt has been performed in the Sources and Use of Fund sheets and debt analysis for the forecasting months in the AR and Sensitivity Analysis sheet.
We can summarize that the increases in assets are inversely proportional to the firm liquidity and equity. The reverse relationship allows a hold for a decrease in the firm’s assets. The firm’s Debt ratio on a month-to-month basis starts at 0.37 in Sept 2012, hits a high of 0.43 in May 2013, and, if the forecast remains accurate, 0.24 by Sept 2013.
2. Will Jackson Automotive Systems be able to repay its loans? Perform a sensitivity analysis on the proforma statements.
Jackson Automotive Systems will only have a cash balance of $7,889,000 at the end of September, so if Jackson decides to pay dividends of $1,200,000 and the loans of $7,400,000, then Jackson will have deficits of $711,000 by the end of Sept.
However, if Jackson can increase the sales by 3% for the rest of the 4 months, then Jackson will be able to pay dividends and loans and still have a cash balance of $108,000. The Analysis was performed as per Jackson’s intended scenario without the addition of dividend payments.
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