CORPORATE FINANCE

Gilbert Lumber
Company

MSc in Finance – Section C

Group C4

Carbonin, Tommaso
El Safadi, Nour
Gerber, Niclas
Kangas, Georgios
Visser, Ole

Barcelona, November 2022

1) GLC operates in the retail industry and distributes lumber products in its local area in the Pacific
Northwest. The lumber industry has been a part of American history and is considered one of the
largest in the world (Jesse, 2020). Notably, the industry is highly dependent on construction and is
sensitive to the state of the economy. In addition, the industry is affected by seasonality. For
instance, wet weather periods might pose issues for loggers to produce sufficient wood compared
to dry periods (Rashad, 2021). Also, construction work is preferably undertaken during warmer
months. Generally, in the lumber industry, success depends on price competitiveness. This is
because the products retailed are made from homogeneous raw materials and are thus very similar
to competitors. Therefore, GLC is focused on distributing price-competitive products.

While GLC is located in the number one region for lumber production in the US, several
measures can be taken to improve its position further (York Saw & Knife, 2022). For instance, it
could hire commission-based sales representatives or implement an online presence to diversify
sales channels. Also, GLC could use its access to railroad sidings to expand its distribution beyond
its local area. This would boost their distribution channels and allow them to compete for a larger
market share. Additionally, by purchasing even large amounts from suppliers, it could take better
advantage of the trade discounts.

From an operation standpoint, GLC continually increased its sales and net profits with a CAGR
of 26% and 19.14%, respectively. This development can mainly be explained but their ability to
provide price-competitive products. They could keep product prices low as they meticulously
managed operational costs. Also, GLC benefits from the fact that its operations are not too affected
by seasonality. This is because 55% of their sales come from repair work, which is not subject to
seasonality. One operational disadvantage is that GLC is limited in its operations, as they only
conduct business locally and distribute a small range of products. The company is performing well
from an operational standpoint due to steady profitability, constant demand, and growing sales.

2) As business operations grew substantially at a CAGR OF 26.00% between 2011 and 2013, more
capital was needed to finance this growth. Some of this financing was done by increased trade
credit and bank loans. However, current liabilities grew at 43.45% CAGR, while current assets and
net income grew at a CAGR of 28.77% and 19.14%, respectively. Additionally, the company had
to make an annual payment of $7.000 because of a loan to acquire Mr. Hernandez's interest in
GLC. Moreover, the cash deposits were depleted by $17.000 over the period. A cash shortage was
caused by increasing inventory days and day sales outstanding, which reduced working capital.
Consequently, GLC could not fund its growth internally and had to rely on additional financing. As
these expansion trends are expected to continue, the company will need additional capital.

3) Profitability: GLC’s gross profit margin between 2011 and 2013 was shallow but stable between
27.62% and 28.61%. Hence, their gross profit margin was approximately 10% lower than the US
lumber wholesaling industry, which averaged 37.8% during the same period (IBISWorld, 2022).
GLC’s net profit margins were 1.83% in 2011 and 1.63% in 2013. This means that the company
had an overall profit of $0.0163 per $1 of revenue gained, which is extremely low. In comparison,
the US lumber wholesaling industry had an average net profit margin of 9.13% between 2011-2013
(IBISWorld, 2022). Regarding GLC’s ROA and ROE, its 3-year average for 2011-2013 was 4.85%
and 11.77%, respectively. This is substantially lower than the US’s lumber wholesaling industry,
which had respective values of 13.23% and 34.43% (IBISWorld, 2022). Therefore, GLC’s
profitability ratios are concerning since they are significantly below the industry’s average

Liquidity: GLC's current ratio is above 1, indicating its ability to repay its short-term liabilities
with its short-term assets, assuming that inventories can be sold quickly. However, the firm's ratio
declined from 1.80 in 2011 to 1.45 in 2013, reducing the firm's liquidity. Similarly, GLC's quick ratio

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 deteriorated from 0.88 to 0.67 during the same period. This ratio is especially relevant to the
company, as more than half its current assets are inventory, which might not be liquidated quickly.
In comparison, the US lumber wholesaling industry averages 1.97 for the current ratio and 1.17 for
the quick ratio over the same period (IBISWorld, 2022). Overall, GLC's liquidity ratios are below
the industry average and continue to decline. However, the decline can be mainly explained as the
business operations grew so fast that the company could not proportionally increase its financing.
Therefore, GLC will only be able to meet its short-term liability obligations if they obtain additional
funding. After all, their business model is very capital-intensive, and they do not have access to
cash or other highly liquid assets.

Efficiency: Since GLC is not retailing its products, it must quickly flip its inventory to generate
sales and cash. If they fail to do so, they have too much capital tied up in their inventory. The longer
this process takes, the less efficient the company manages its assets and the higher the risk of the
products losing value. The inventory days of the company have been deteriorating from 63 days in
2011 to 70 days in 2013. Therefore, GLC needs fewer days to sell its inventory, which is desirable
as this reduces holding costs, increasing profits. Apart from that, accounts receivable days have
also increased from 37 days in 2011 to 43 days in 2013. Most sales come from the repair business,
making it easier for the company to purchase the right amount of inventory than its peers.
Conversely, GLC's cash conversion cycle could be more optimal. They only receive payments from
the sales made after their payments to their suppliers are due. We can calculate this cycle by
combining the inventory days and accounts receivable days. By doing so, we find that this cycle
has increased from 100 days in 2011 to 113 in 2013, which means the company has lost efficiency.
A larger operating cycle requires more cash to grow its operations. Ideally, the operating cycle
should be as low as possible to reduce the business's cash requirements. Lastly, GLC's sales to
working capital ratio have been steadily increasing from 8.16 in 2011 to 11.18 in 2013, as opposed
to 2.5 for the industry average (IBISWorld, 2022). This indicates that GLC is more efficient than its
peers at generating sales, given its working capital.

In summary, GLC is less profitable and has much more significant liquidity concerns than its
peers. Also, its operating cycle is inefficient. However, it is operating much more efficiently in
collecting receivables, selling its inventory, and utilizing its working capital than the industry
average.

4) An overview of the uses and sources of funds during 2011 and 2013 can be seen in Exhibit A.
Over this period, the primary sources of funds were notes payable (49.05%), accounts payable
(27.79%), and net worth (16.42%). Contrarily, the primary uses of funds were accounts receivables
(30.74%), inventory (37.68%), and the note payable to Mr. Hernandez (22.11%). However, one
needs to point out that the payment to Mr. Hernandez was a one-time payment of $105.000, diluting
the typical use of funds. Therefore, the uses of funds in 2013 are more representative of the usual
business operations. This year’s primary uses of funds were accounts receivables (45.02%) and
inventory (43.60%). Additionally, one needs to point out that over the entire period, accounts
receivables and inventory grew by a CAGR of 36.15% and 32.25%, respectively. This indicates a
growth in sales and a build-up of inventory to manufacture the additional products sold. This
business expansion was mainly financed by increased trade credit and bank loans. For instance,
during the period, accounts payables have increased by $132.000 (CAGR 43.86%) and notes
payables to the bank by $233.000 ($0 in 2011). In contrast, cash only contributed $17.000 to the
source's funds and net worth $78.000.

5) The annualized cost of trade credit for GLC is 44.6% which was derived from the following formula:
{(1+0.02/(1-0.02)}^{365/(30-10)}-1. This means that GLC is paying 44.6% annualised interest if it
chooses to pay at the due date in 30 days. Comparatively, the short-term bank loan has a 10.5%
interest. Therefore, it is more economical for GLC to obtain the short-term loan, pay within ten

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 days, and receive the 2% trade discount. By doing so, GLC will be more cost-efficient and can
strengthen its relationships with its suppliers. Furthermore, even though the suppliers do not
complain about lagged payments beyond 30 days, paying within the first ten days ensures that
GLC will avoid paying additional interest charges for late payments. Lastly, by applying a 2% trade
discount on the account’s payables, GLC could have saved $16,300 from 2011 to Q1 of 2014.

6) To decide whether Mr. Gilbert's estimate of the company's loan requirement is reasonable, the
income statement and balance sheet must be forecasted (EXHIBIT B). To begin, given the $3.6M
sales projection in 2014, we forecasted both COGS and operating as a percentage of revenue.
Then, the three-year average of the preceding years was used to compute interest expense and
income tax provisions. As a result, the company is estimated to earn net profits of $62.000. Second,
to anticipate the current assets position in 2014, we used its 2011-2013 CAGR to determine the
expected percentage of current assets to sales. As a result, current assets in 2014 are estimated
to reach $1.044.000. The average growth in PPE was then used to calculate the expected long-
term assets, which amounted to $167.000. Hence, we estimate GLC's total assets to be
$1.211.000 by 2014. Next, we calculated equity by adding the projected net income for 2014 to the
total equity from the previous year, which yielded $410.000 in equity. Finally, we predicted liabilities
by adding 2014’s first quarter total liabilities to the difference between total assets and total
liabilities plus equity. Consequently, $64.000 of external financing was required. However, GLC
still needed to repay Ferryn National Bank's outstanding debt of $247.000. Therefore, Gilbert
Lumber Company's total required loan amount rose to $311.000. Hence, Mr. Gilbert’s new credit
line from Khai National Bank would be sufficient to fund his needs for 2014. Also, it would leave
him with $154.000 of additional credit to fund operations in the future. Thus, he would not need to
renegotiate credit terms in the new future.

7) From a strategic standpoint, expansion is a sound decision as the company grows profitably. Also,
the fact that GLC currently only operates regionally provides them with the extreme opportunity to
expand their business. However, we observed a worsening debt-to-assets ratio in Mr. Lumber's
company, from 0.55 in 2011 to 0.63 in 2013. Nevertheless, this is a viable ratio, significantly below
1.0, meaning the company can take on additional debt. Furthermore, the debt-to-equity has
worsened from 1.20 in 2011 to 1.68 in 2013. However, this ratio remains significantly below the
industry average of 2.6 (IBISWorld, 2022). This indicates that GLC can afford to take more
leverage, as it is not taking advantage of debt to finance its operations. Nevertheless, increasing
reliance on debt must be carefully watched to ensure that additional loans do not lead to over-
leverage. To form our final decision, we conduct a FRICTO analysis to evaluate all aspects:

Flexibility: By taking on the additional loan, GLC will have to give up flexibility in their operations
as they need to get the bank's approval before conducting any significant decisions. This might
force the firm to forgo certain promising opportunities.
Risk: Debt financing is riskier as steady interest payments must be made to creditors, and failure
to do so could result in default. In addition, considering that GLC operates in an industry highly
driven by economic performance and seasonality, additional leverage might pose financial distress
to the firm during economic downswings. However, due to GLC's high proportion of repair
business, their sales are protected from those fluctuations to a certain degree. Yet, this might
change if the ratio of repair work to overall sales decreases while the company grows. In this case,
they will be more sensitive to industry trends, increasing the risk to the company.
Income: The overall interest expense of the company will rise, thereby increasing the cash
outflows of the company. However, percentage-wise, the interest paid will be lower with the new
loan. Also, the additional tax shield will further lower EBIT, thus reducing income taxes. The
increased interest expense should be acceptable if the company can conduct profitable operations
with the additional capital.

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 Control: As no equity is given up, the additional debt will not dilute the company’s control. This
is especially valuable to Mr. Gilbert as he recently took on a loan to obtain complete control over
the.company.
Timing: As the loan is a revolving, secured 90-day note, refinancing itself will be secured.
However, as the interest rate is floating, GLC might face unexpectedly higher costs that could pose
trouble to them
Other: By taking on the new loan, GLC will have to terminate its relationship with the previous
bank. While sufficient other banks are available on the market, it is always better to have multiple
banking relationships to reduce dependence on a single lender.

Other options for financing would be to internally fund part of the expansion with the company's
cash. This funding option is the least expensive as GLC will not owe any debt. Furthermore, Mr.
Gilbert's annual salary increased by $20.000 in the last two years. However, If Mr. Gilbert would
be willing to reduce his salary to previous levels, this capital could also be used to finance the
expansion internally. Apart from this, he could sell equity stakes to family and friends. This
alternative also does not require any payments, yet, it will dilute the company's ownership, which
might not be in the interest of Mr. Gilbert. Lastly, Mr. Gilbert's wife could sell her stake of $27.500
in the house she owns and invest that into the company. Although, we would not recommend doing
so,.as.it.is.wise.to.diversify.your.income.sources.and.assets.held.

In conclusion, the financial means Mr. Gilbert can obtain apart from the loan are pretty limited.
Also, GLC needs to generate more cash to fund its internal expansions. Still, the firm needs
additional funding to support its continual growth in sales. Thus, as Mr. Gilbert's advisors, we
suggest he takes on the loan from the Khai National Bank. The company is in healthy condition,
has a viable business model, and has promising opportunities for the future. Therefore, it will be
able.to.repay.the.additional.interest.

8) As the banker, we would approve the loan to Mr. Gilbert due to the company's steady rate of
profitability and the expected growth in sales. In addition, the future success of the business model
is not subject to substantial risk. This is because the company provides an essential service, has
good relationships with its suppliers, offers competitive pricing, and has established an excellent
reputation in its region. However, certain conditions must apply if the loan is approved, as it would
substantially increase the company's debt level. In addition, the growth achieved through the loan
could result in the GLC needing additional loans to grow further. Therefore, GLC will be subject to
the following conditions unless the bank approves otherwise:

1. It cannot take on any additional financing, regardless of the source

2. It cannot make any distributions to the shareholders or other parties
3. It must maintain a quick ratio above 0.65
4. It cannot make any sale or investment into assets worth more than $50.000
5. It must terminate its relationship with Ferryn National Bank
6. It must maintain a debt-to-equity ratio below 2.5
7. It cannot raise Mr. Gilbert’s salary

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EXHIBITS

Exhibit A

Exhibits B

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REFERENCES

IBISWorld. (2022). Key statistics ratios. www.ibisworld.com.

https://my.ibisworld.com/us/en/industry/42331/key-statistics#key-ratios

Jesse (2020) Global timber and wood products industry factsheet 2020: Largest Wood producing
countries, largest wood exporters and importers, Bizvibe Blog. Available at:
https://blog.bizvibe.com/blog/largest-wood-producing-countries. (Accessed: November 5, 2022).

Rashad, A. (2021) Top 5 factors that affect international timber prices, Supply Chain Tools.
Available at: https://www.timber.exchange/blog-details/top-5-factors-that-affect-international-
timber-prices (Accessed: November 5, 2022).

Statista. (2022) Lumber production in the United States 2019. Available at:
https://www.statista.com/statistics/252698/lumber-production-in-the-us-2001-2010/ (Accessed:
November 5, 2022).

The largest sawmills & Lumber producing states in the U.S. (2022) York Saw and Knife. Available
at: https://www.yorksaw.com/guide-to-sawmills/sawmills-in-the-
usa/#:~:text=According%20to%20the%20Oregon%20Forest,Georgia (Accessed: November 8,
2022).