Envy Riders Incorporated Harvard Case Solution & Analysis

Envy Riders Incorporated Case Study Solution

Capacity – the PLUG method

Projected income statement

The income statement is projected with the use of the various assumptions provided in the case. The sales of the company are projected to be increase to 6 million dollars in the fiscal year 2010, whereas the sales of the company are projected to be increase to 7.5 million dollars in the fiscal year 2011 which is 25 percent more than the sales of the year 2010. The estimates of the sales are quite aggressive due to the fact that it is believed by Hessels that these sales estimates would most likely reflect a significant increase in the sales of motorsport through the expansion of company into the tattoo business and stronger marketing initiatives.

In addition to this, the beginning inventory for 2010 is similar to the beginning inventory for the year 2009 whereas the beginning inventory for 2011 is the ending inventory of year 2010. The purchases for the year 2010 and 2011 is calculated by using the formula (cost of goods sold – beginning inventory + ending inventory). The terms of the inventory days is 312 which is similar to that of the fiscal year 2010 whereas the terms of the inventory days is reduced to 270 for the fiscal year 2011. The gross profit is calculated after deducting the total cost of goods sold from the total sales.

  • The fiscal 2010 and 2011 would remain same in rent and utilities whereas the salaries of the employees are projected to be increase to 12 percent as well as 13 percent of sales respectively.
  • Also, the advertising and promotion are projected to be increase to 1.5 percent of sales in year 2010 and 2011 respectively. Similarly, the automotive expenses are projected to be increase to 0.7 percent of sales in year 2010 and 2011 respectively.
  • The telephone expense, license fees and duties are projected to be increase to 0.3 percent of sales in year 2010 and 2011 respectively. The office expense are also estimated to be increase to 0.3 percent of sales in year 2010 and 2011 respectively.
  • The fiscal 2010 and 2011 would remain sale in insurance fees and the professional fees is estimated to be increase to 0.1 percent of sales in year 2010 and 2011.
  • The long term interest on the loan amount of 60000 dollars is calculated by applying 9 percent interest rate on long term loan which amounts to $5400 whereas the interest rate of 9 percent is applied on the ending balance of the first year loan amount which amounts to $4806.
  • The amortization amount is calculated with the use of the straight line amortization over the period of 15 years. The amortization for the prior year is added into new loan of $60000 which is divided by number of years, hence resulted in $19348.
  • The net income after tax for the year 2010 and 2011 amounts $89632 and $137430 respectively.

From the standpoint of the financial institution, the financial position of the Envy Riders seems strong as the net income is positive for both projected years after incorporating the effects of the loan principle and interest payment. (See Table 1)

Projected balance sheet

The balance sheet of the company is projected on the basis of certain assumptions, which are discussed below;

  • On the current assets side, the fiscal year 2010 and 2011 would remain same in the cash, prepaid expenses and supplier deposit.
  • Additionally, the account receivable balance is calculated by multiplying the accountreceivabledays into total projected sales.
  • In addition to this, the new asset incorporated in the fixed assets side with the amount of the long term loan for the building renovation. The old fixed assets of the company would remain same to prior year.
  • Furthermore, the working capital loan is calculated by deducting the total liabilities from the total assets whereas the account payable is calculated by multiplying the total cost of goods sold with the account payable days for both years 2010 and 2011.
  • The fiscal year 2010 and 2011 would remain same in the customer deposits.
  • The loan repayment amount on $60000 loan balance is $12000 per year, which is incorporated in the long term liabilities section with the name of bank loan.
  • The shareholder advance and capital stock would remain same for both years 2010 and 2011.

After taking into account the project balance sheet analysis, the financial status of the company seems strong. The strong balance sheet of the company possess most attributes which includes income generating assets, a balanced capital structure, intelligent working capital and positive cash inflows. Another reason of the strong financial status of the company is that the total assets of the company are higher as compared to the total liabilities. (See Table 2)

Sensitivity analysis

The sensitivity analysis is performed with the use of the different account payable and account receivables days, other things remains same in order to assess and evaluate the repaying capacity of the company. The changes in the account receivable days falls within the range of 110 and 185 days whereas the changes in the account payable days falls within the range of 24 and 70 days.

In order to judge the repaying capacity of the company, sensitivity analysis has performed, with the changes in the account receivable days and the changes in the account payables days. With 120 account receivable days and 50 account payable days, the total current assets are increased from the projected value of $4388628 to $6306585. The high account receivable days shows weak credit policy of the company and increasing problems with the colleting receivables in timely manner. On the other hand, with 50 account payable days, the total liabilities are reduced from the projected value of $2322764 to $708740. The high account receivable days shows weak credit policy of the company and increasing problems with the colleting receivables in timely manner. As compared to the projected balance sheets in which the company takes 175 days to pay its creditors, in the sensitivity analysis, the company takes reduced days which are 50 days for the payment to creditors which shows that the company would make early payments to the creditors due to which the company would not have enough cash on hand which might make bank reluctant to lend funds to the company. It is because of the fact that the financial position of the company does not seems strong as the current assets are lower as compared to the current liabilitieswhich provides weakevidence that the company would be able to pay off its debt obligations in the forthcoming years.

Criteria

The alternatives which are presented to bank is analyzed on the basis of some key elements which would help in deciding whether to grant loan and accept the loan request of Envy Riders.

Character

Envy Riders is valuable and leading brand with the positive market image and customer loyalty, it is because of the reason that many years of experience in marketing roles and entrepreneurial activities and in-depth knowledge and understanding in the field has helped the company to flourish and prosper. The company has strong and positive relationship with the investors who could provide the company full support in its expansion plans. Additionally, the company has been engaged in marketing activities which targets the customers and offer the accessories and apparel that supplement the purchase of recreational vehicle.

Capacity

Envy Riders has enough cash flows to serve the debt obligation in the future. There would not be any disruption in the payment of the loan principle and interest amount because the company has enough assets and cash flows that could be used to pay off the debt obligations. Additionally, the financial ratios of the company demonstrates sufficient financial status of the company.

Capital

In the evaluation of the financial standing of the company, the banks or financial institution would not be ready to lend the funds to those companies with excess use of debt. The financials of the Envy Riders shows not debt obligations and dues due to which the bank could lend funds to Envy Riders.

Collateral position

The collateral position of the company is strong as the company could offers the assets as a way to the bank to secure the loan. The assets of the company for the year 2009 includes cash, account receivable, inventory, fixed assets and new loan, accumulated to $2814182. Afterdeducting the long term loan, the company would have excess collateral of $1358698.

Condition

Due to the economic downturn, the purchasing power of the customers is highly affected. They are not ready to purchase the luxurious items due to their weak borrowing capacity. Furthermore, the recreational motorsport industry is subject to the fluctuations in the seasonal sales of products. Additionally, the competition is intense in the market between market rivals due to which there is a likelihood that the competitors steal the market share of Envy Riders in long run.

Evaluation of alternatives

From the qualitative and quantitative standpoint, the financial situation of the company seems feasible due to which the bank has choice to accept the loan request from Envy Riders. On the basis of the five C’s (key elements to consider before deciding whether to grant loan to Envy Riders), the evaluation of the alternative is as follows;

The company has strong brand image and market knowledge and experience, it has built strong relationship with the investor who could lend funds to the company for its further growth through acquisition and expansion in the international markets. The capacity has enough cash flows and the strong financial position that provides strong foundation that the company would not face any difficulty in making payment of the loan to banks.

Recommendations

On the basis of a detailed analysis of the internal and external conditions on Envy, with an inclusion of the evaluation of alternatives on the basis of a detailed criteria, the bank is recommended to grant loan to Envy as it fulfills four out of the five major decision criteria. It could be seen from the above table that granting loan could be an effective option for the bank and could provide substantial returns to bank as Envy has a strong character, capacity, capital and collateral. Although, the market conditions with declining trends of purchasing luxury items put a question mark on the future of Envy but the strong position of Envy under other decision criteria reduces the chances of losses for bank due to conditions.  Envy’s strong position in market with a potential image among consumers, its capacity to pay debt obligations with substantial amount of cash in its balance sheet, its capital structure with more amount of equity than debt along with its ability to file a strong collateral with huge amount of long-term assets in its balance sheet provide a strong basis for the bank to grant loan to Envy.

Action Plan

  • Despite of the strong position of Envy under the four decision criteria, the management at bank must conduct a detailed analysis regarding the stakeholders concerns with the future of the firm, the perceptions of the shareholders about investing in the firm, the concerns of other debt holders, market value of Envy under various asset valuation methods, the future plans of the firm, etc.
  • Along with a detailed analysis of the company itself, a detailed market analysis is also required with evaluation of market conditions including the consumers’ purchasing behavior, the overall economic conditions, future inflation, and pressures from the global and local competitors etc. to come up with an optimal decision.
  • After conducting of the detailed analysis of company and market, the bank then could proceed to determining the effective rate of interest that could be charged on Envy on the basis of the current credit rating of the firm with future plans and investors’ perceptions about the firm. The interest rate could also be based on the return that a typical bank earns from firms like Envy.
  • After determining the interest rate, the bank then could proceed to negotiating with the firm’s management about the installment payment, the interest rate, the duration along with the details about collateral. Followed by the negotiation stage, the Bank should build an agreement including the detailed terms and conditions about granting loan to avoid any type of dispute in future.
  • After all these formalities, now the bank can gather the funds to transfer to the firms account followed by a watchdog on the payment schedule of installments.

Conclusion

In conclusion, it could be said that having a strong market position with a strong image among customers, a strong internal and external market position, efficient financial and operational performance etc. make Envy an optimal debtor for the Bank as the chances of default of Envy with its current performance are low. The bank can earn substantial returns by granting loan to Envy at an effective rate of interest that could be further invested to achieve more returns. Therefore, granting a loan to Envy could be considered as an optimal option..............................

 

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