Brick House

Brick House 

1. Below are the projected Income Statement, Balance Sheet, and Cash Flow Statement along with the accompanying PP&E Schedule. 

Black: Numbers transferred from the exhibits without any changes 

Assumptions: In all cases (except tax rate), the assumptions are based on the 4-year average between 2012A and 2015F. The numbers from 2011 and before were ignored since 2011 represents the year of the earthquake, making the numbers from that year not indicative of Brick House’s numbers going forward. Taxes were kept constant at the 2015(F) levels. 

From the above numbers it is apparent that while a credit line of NZ$750,000 may be sufficient for Brick House to get through 2016, it will likely require a credit line greater than NZ$750,000 in the years after. The credit line needed is both a function of the sales growth and the way the business is run (i.e. inventory management, terms of credit with customers/suppliers, etc.). However, assuming the way the business is run is kept the same and in line with the above assumptions then the credit line needed as a function of the sales growth are: 

Unsurprisingly, given the large working capital requirements, Brick House’s credit line requirement is directly proportional to the sales growth rate because more cash would be needed to keep up with increasing inventory and accounts receivable figures. The increasing credit limit or debt would further increase the financial leverage of Brick House as shown below: 

Thus, the financial leverage would continue to increase if the credit line were extended to keep pace with the sales growth. However, the higher the sales growth the more stable the financial leverage ratio (Liabilities/Net Worth ratio) becomes because the increasing sales contribute to increased profits allowing the net worth to keep up better pace with the liabilities through the increasing retained earnings. Having said that, the financial leverage does continue to rise albeit more steadily. 

2)  

Brick House could potentially (i) take out additional debt financing, (ii) raise equity (i.e. Lizzie subscribing for more shares in Brick House, by, for example, investing proceeds from (re)mortgaging her flat), (iii) reduce its working capital investment (i.e. reducing inventory and/or decreasing (increasing) Accounts Receivables (Payables)), iv) selling the receivables to financial institutions at a 20% discount for a one time cash inflow to deleverage, and/or v) preventing Lizzie from increase her pay via salary or dividends (although, admittedly, this would have a limited impact).  

Out of the options outlined above, (iv) is most likely to be a realistic alternative to large credit line considering Lizzie is unlikely to want to increase exposure of her personal wealth especially given recent salary decrease. (iv) would result in a significant one-off reduction in ROIC; however, in the following years the ROIC should improve due to the benefits of deleveraging given all else equal and that the large cash inflow from AR sale is used to pay off debt obligations. In our view (iii) would be the preferred option as it is affordable to adopt; increases ROIC substantially (barring year 0) and generates significant amount of cash upfront for the business.