Finance/Banking experts or anyone…………..IF YOU HAVE ENOUGH TIME…. Please read the case and throw some ideas about how to start this case… Honestly this is my assignment and I am trying to get some ideas only……. I took current prime rate and directly started trying to find out which bank would be cheapest for the company. But my calculations did not made sense as there is interest and service charge factors…. So, as I said before… throw some directions…
CASE:
Kathy Baker, the treasurer of ABC Boat Company, is planning her short-term financing needs for the next year. She has estimated the cumulative operating cash flow needs to be as – Jan $100,000; Feb $1,750,000; March $5,500,000; April $7,500,000; May $8,000,000; June $8,000,000; July $6,000,000; August $4,500,000; Sept $ 1,500,000; Oct $500,000; Nov & Dec $0.
Ms. Baker feels fairly confident of most of the items in the forecast, with one exception: sales. Both the seasonality of the business and the state of the economy have invalidated forecasts in the past. A study done by an intern from the state university last summer compared the forecasted cash flow with the actual flow on a monthly basis for a 5-year period. The intern’s report showed that the forecast error had a distribution with an expected value of 0 and a standard deviation of about 10%. Ms. Baker knew that this factor should somehow be incorporated in the planning for the credit agreements, but she wasn’t sure how to do so. It had been a long time since her MBA statistics course, which was the last time she worked with probability distributions.
She has made preliminary contact with the company’s two banks concerning the terms and the amount of credit line they might be wiling to consider for ABC. The 7th Avenue national Bank has quoted terms of the price rate plus ¾% for a maximum credit line of $12,000,000, which would require a compensating balance of 5% of the amount of the line, regardless of the usage on the line. Bank de Boulevard has quoted the price rate plus 1% on a line of up to $10,000,000, with a commitment fee of ¼% of the amount of the unused line.
The ABC Boat Company currently maintains its general disbursement account and the company’s lockbox at the 7th Avenue National bank. The bank allows compensation for services by a mixture of fees and balances, but insists that at least half of the charges must be covered by balances. ABC carries an average balance of $500,000 at the 7th avenue bank to compensate for services. Service charges are estimated to be $2300 per month and will just be covered by the average balance.
Bank de Boulevard is used for payroll and other specialized disbursing accounts. ABC carries an average balance of $150,000 at this bank, which just covers service charges for the accounts. Bank de Boulevard requires that service charges be covered by balances and not cash fees.
As the new assistant treasurer who will be working with the banks in the future, you have been asked by Ms. Baker to prepare a recommendation on the size of the credit line that ABC should obtain, and which bank should provide the company’s credit line this year. As she left your office she said, half to herself, “Now I can go and work on the marketing manager about changing our credit terms to speed our collections. I ‘ll bet we could advance about $1million from March and April by getting rid of that stupid seasonal dating plan on our Century line of boats.â€
Although banking relations are important in the decision, you know that Ms. Baker is highly influenced by the lowest-cost alternatives. Furthermore, since both banks want ABC’s business, there may be some room for negotiation on the term of the credit line.
As you start on your case, you realize that you will have to make an assumption about the prime rate for the next year. Both banks currently have the price set at 9%, and tend to raise and lower the rate within a few days of one another. After glancing at several business periodicals, you conclude that the estimates of the “experts†range from a drop of 100 basis points to rise of the same magnitude.
