Applied Corporate Finance – the Brick House Case

Applied Corporate Finance – The Brick House Case

Group 10

Q1) Debt requirement based on Growth Scenarios

Credit Line: A credit line of NZ$ 750,000 will not be sufficient if Ms. Ward if she wants to grow the business at the current rate of 25%-30%. At 30% growth rate, the immediate credit line requirement is NZ$ 832K at the end of 2016 and more than NZ $3M by 2020. The exhibits at the end show the credit line requirement under different growth scenarios.

Ratios:

• At the current growth rate, the interest coverage ratio declines to 1.55x in 2020 from 2.02x in 2015.
• The capital structure also deteriorates drastically with Liabilities to Net worth ratio increasing from 2.30x in 2015 to 5.54x in 2020.
• For higher growth rates of 25% and 30% we have also assumed further increase in Days Receivables and Days Inventory as we assume that the co. will need to allow even more credit to capture customers from competitors and will also need to hold higher inventory in anticipation of high growth targets.

Q2) Alternative sources of financing

We have identified the following alternatives to a larger credit line:

a)  Direct equity injection through mortgaging owner’s flat: This is a preferred option since it will not only improve the capital structure of the company, but also indicate commitment to the bank and will help reduce interest rate by lowering risk. This presents a large personal risk to Ms Ward however.

b)  Equity injection through a business partner: This is a preferred option as it would improve the capital structure and also lower cost of debt through reducing risk. However, the company’s ROIC has been registered consistently below 8% therefore it will be challenging to meet the required cost of capital for an equity partner.

c) Factoring: through selling Accounts Receivables (A/R) to the bank the company could potentially improve its liquidity position & cash conversion cycle by taking A/R off the balance sheet and converting them into cash. Potential benefits include higher liquidity and lower risk of default from the buyers as ideally risk is transferred to the bank purchasing the receivables.  

d)  Secured Long Term Debt: The company is expected to make significant CAPEX investment to sustain current growth level (~NZ$ 400K in 5 years). The structure of secured long term debt may be more acceptable to the bank since it will provide direct collateral in the form of security over fixed assets. May be preferred over straight short term credit line as the bank may provide more flexible terms and price the loan lower due to higher security and lower risk.

e)  Supply chain innovation: Optimising the current inventory and classifying the products as A/B and C based on the sales and cutting down on the long tail end product offering to reduce inventory exposure risks

f) Re-negotiating terms of contract with supplier: Now that the business is growing, BrickHouse is buying more and more materials from the supplier, Ms Ward can re-negotiate the terms of deal with the supplier to (i) either be able to order in smaller batch size quantities (reduces inventory exposure risk) or (ii) get better rebates on the earlier 10 day payment.