Reference no: EM133358926

Case: ELLINGTON INDUSTRIAL SUPPLY INC. 2010-01-21 In June 1995, Jake Ellington was working out the financial details of a tentative plan to build an extension onto his warehouse. He was concerned about what source of funds he should use in order to raise the $100,000 required for construction costs. THE COMPANY Ellington Industrial Supply Inc. (EISI) was a distributor of machine tools, maintenance parts, and related equipment in Lakeside. One hundred kilometres north of a metropolitan area and situated on a large lake, Lakeside was the largest and fastest growing industrial centre in its region with a population of 55,000. In addition it served the surrounding farming communities and summer cottage trade. The customers of EISI were mostly industrial maintenance departments, but there was also some high margin retail business, principally from farmers in the surrounding area.

Ellington purchased the business from its previous owner, Mr. Hodges, in February 1992. As part of the purchase agreement, Hodges took a note payable from EISI. By 1992, Ellington had already gained wide experience in a series of jobs. He had worked for a variety of different companies, including one of his current metropolitan-based competitors. During those years, however, he was dominated by a persistent ambition to operate his own business. His first personal venture was a retail hardware store in Riverton, which he sold when he acquired EISI.

Ellington felt pleased with the progress his company had made in the three years since he had purchased it. He had enjoyed considerable success in building up sales. His confidence was such that, in August 1994, EISI purchased its rented facilities, when the landlord offered the property to EISI at what Ellington regarded as "a very attractive price". By June 1995, monthly sales volume averaged more than $100,000. (Exhibits 1 to 3 present the past three years' financial data and selected company and industry financial ratios.) Ellington was also proud of the company's reputation for dependability and integrity. He believed his success was due largely to the personalized service and engineering advice he offered his customers. He Page 173 of 293 For use only in the course ADMN2167-WI001 Business Decision Making at Nipissing University from 1/9/2023 to 4/1/2024. Use outside these parameters is a copyright violation. Page 2 9A99N022 also realized that an important factor in attracting new customers and building lasting customer relationships was his success in obtaining exclusive rights to handle the products of some of the better manufacturers.

Maintaining good supplier relations with those manufacturers who granted him exclusivity was a key element to future success. COMPETITION Until late 1994, EISI had been the only distributor of machine tools and parts in Lakeside. Competition had come from salespeople operating from out-of-town warehouses. In the fall of 1994, another distributor started up an operation in Lakeside. Ellington believed, however, that the new competitor would not conflict directly with more than a small part of his business because of the exclusive distribution rights EISI held and its specialized products. This new distributor also did not as yet have the reputation for dependable service that EISI had earned. THE FUTURE Although market information was limited, Ellington thought that EISI had about 35 per cent of the machine tool and equipment market in Lakeside and the surrounding region. Given the existing market potential, he believed sales could not increase beyond $2,000,000 without expanding EISI's geographical market area. For the next two years he projected probable sales at $1,400,000 for the year ending January 31, 1996, and $1,600,000 for the year ending January 31, 1997. However, he felt sales could fall as low as $1,300,000 and $1,500,000 for fiscal years 1996 and 1997, respectively, or go as high as $1,600,000 and $1,800,000. THE PROBLEM In June 1995, one of Ellington's major concerns was the cramped space in EISI's warehouse. He felt EISI could not handle any significant increases in inventory on hand with its present facilities. In order to maintain the high standard of service and delivery, he wanted to add a warehouse extension as soon as possible. At the same time, one of his top priorities was to reduce the age of EISI's accounts payable to 60 days before the end of the fiscal year. If he failed to do so, he feared that he would put some of EISI's exclusive distribution agreements in jeopardy. First, Ellington wanted to determine the amount of money EISI needed to carry out these plans, and then to decide on the appropriate source of funds. EISI's existing long-term debt-servicing schedule is provided in Exhibit 4. Several options were available. His preference was to borrow either from the bank or from a private lender. He did, however, have another alternative, namely selling shares in EISI to a local investor. At the time of his decision, Ellington was hesitant to use equity financing. He felt he would not get as much now for a share in the company as he could expect in a year when his hard work had paid off through increased profits. He was also wondering about the company's capability of generating its own funds

Question 1. How much cash will Ellington Industrial Supply Inc., (EISI) generate/require in the next two years based on low and high estimates? Assume EISI's corprate income tax rate averages 25%

Question 2. Which source of funds should be used for the warheouse and any other requirements?

Question 3. What would the effects of shortfall or overshooting on the sales forecasts have on the operation?