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Rushway Brothers Lumber and Building Supplies LTD Case Solution
The case study is based on the valuation of the business to find out about the worth of the business. It also deals with the forecasting of cash flows which includes assuming a reasonable growth rate and finding out the operating earnings of the company. The idea is to calculate the cash flows to equity and discount it back to find the present value of the firm. It also requires calculating the appropriate discount rate for present value purposes. In this case, as the cash flows to equity are estimated the discount rate that will be used is related to the cost of equity only. All the forecast for cash flows are estimated for five years, and the terminal value is estimated at the end of the fifth year.
Following questions are answered in this case study solution
Decision and Plan of Action
Case Analysis for Rushway Brothers Lumber and Building Supplies LTD
Rushway Brothers Lumber and Building Supplies Ltd is operating in Ontario Canada and serving the retail market for home improvements and also serves the wholesale contractor market for single family dwellings and other buildings. The business has two divisions merchandising and construction. The merchandising business offered various home building and repair products including paint, hardware, plumbing supplies and small tools and was based in a retail store and a lumber yard. The construction business was related to building wood framed, steel sided structures for agricultural, commercial, recreational and industrial use. This part of the business account for more than 50% of the total sales.
After the death of the owner Douglas Rushway, the company was headed by the former manager of the London branch Charles Conway. During his supervision, various alarming signal starting rising focusing on the financial reporting part of the operations. For example, the inventories were overstated and also the bank loans and the finance cost as well. The profit distribution to the stockholders was drastically fallen. Multiple warnings were given from the bank to Gordon Rushway. This has lead to the takeover of the company by Charlotte Bradley, who was the daughter of Gordon Rushway.
Working persistently on the business for two years has left Bradley with a thought that what she wants to do with the rest of her life? She barely had recreational time in last two years and had dedicated herself completely to the work. She is planning to sell the business for which she needed an estimation of the worth of the business. At the same time, she is very attached and emotionally connected with the business as a whole and the staff.
Bradley had two alternatives at the moment. Firstly, she can find out the worth of the business by estimating the total value of the equity. If the value of the firm presents a reasonable estimate, she could start finding the interested buyers. If she gets an offer which close to the estimate of the firm, she can sell the business and use the proceeds to invest in various financial instruments including government securities, the stock market, and derivatives. But at the same time she had to find a job as well. The second alternative is to continue running the business and retaining the profit to expand it.
The criteria for evaluating the alternatives vary from option to option. The first alternative would be evaluated by finding out the total value of the equity which would indicate the inflow of cash that would occur in selling off the business. Then if the proceeds invested in government securities and the return is calculated based on the long term interest rate. This return then will be compared against the profit of the business that it is expected to generate. If the profit of the business is greater than the return from an investment, then not selling the business would be beneficial and vice versa for the case when profit is less than the investment return.
• Qualitative Analysis
The decision to sell the business depends on various factors which should be accounted while making a decision. For example, the economic recession hit the Canadian market very hard and reduced the demand for home construction and contractor customers of Rushway also decreased significantly. The recession caused to reduce the prices which lower the sales and the net profit margin also fall.
Currently, the inventory valuation method is used which value that the cost of goods sold is based on the recoverable amount. It means that the most recent purchases are sold, and the items carried in inventory are previously purchased.
The total market value of both the lands of the business is $550,000 which is more than the book value. The company has used the land as collateral for obtaining term loan form the commercial mortgages. In real estate market in the country is very much depressed right now
From the bank point of view, the recovery of the loan is questionable. Moreover, the company agreed to get a term loan from the bank at the rate prime plus three-quarter percent which is more than the current rate of prime plus one-half-percent. The interest cost for this loan is greater thus increasing the leverage of the firm.
If Bradley had to sell of the business, she would have to look for another job. Also, the employees have developed an attachment to her and could affect their motivation resulting in lower productivity.
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