Question 2. Lending Case Study. (20 marks) ZZZ is a well-established builder

Question 2. Lending Case Study.  (20 marks)

ZZZ is a well-established builder and has banked with Monash bank for ten years.

The business of ZZZ has provided a good income in the past and it includes ‘small works’ contracts, alterations, extensions, refurbishment and some ‘new build’ contracts for private customers and small developers.  ZZZ won a bid to construct a building for the local government one week ago. ZZZ has approached you as a responsible loan officer, to obtain financing for this project and it offers the latest financial reports to you.

 

 

ZZZ Balance Sheet

 

2019

2020

2021

 

$million

$million

$million

Fixed Assets

 

Plant and Machinery

600

680

820

Vehicles

50

90

95

 

650

770

915

 

 

Current Assets:

 

Debtors

610

620

660

Land

230

230

240

Work-in-progress

1,021

1,033

967

 

1,861

1,783

1,867

Current liabilities

 

Creditors

380

350

365

Tax

17

19

23

Hire Purchase

320

620

550

Bank overdraft

500

500

600

 

1,217

1,489

1,538

Net current assets

1,294

1,064

1,244

 

 

Finance by:

 

Issued share capital

1,000

1,000

1,000

Profit & Loss account

294

64

244

 

1,294

1,064

1,244

Income Statement

 

2019

2020

2021

 

$000

$000

$000

Pre-tax profit

260

313

348

Depreciation

82

64

95

Interest

4

4

5

Directors’ remuneration

123

151

167

Audit fees

30

40

50

Tax payable

12

14

13

Retained profit

12

20

21

Sales

1,545

1,444

1,456

Accounting Ratios:

 

 

 

 

2019

2020

2021

Gearing (%)

63.3694

105.263

92.4437

Net Margin (%)

16.8285

19.0389

21.0145

 

 

 

ZZZ has thirteen(13) months to complete the construction. The total contract price is $880 million .  It is estimated that ZZZ will make a profit of 22% of the contract value.  Labour costs and material costs are expected to be 67% and 33% of the construction costs, respectively. As this is a relatively straightforward project for ZZZ, it is safe to assume that construction progress will be spread evenly over the life of the project. Salary will be paid out in the middle of each month.

 

Interim payment certificates will be issued at the end of each month, and the corresponding payments received from its customer will occur two months after the issue of the progress certificate. Therefore, the builder will receive the first monthly payment at the end of the third month.

 

At the beginning of the project, the initial retention fund of ZZZ should have 4% of the total contract value.  Additionally, ZZZ has to set up a retention fund which will require retentions at the rate of 8% of the monthly payments.

 

As a well-established construction company, ZZZ expects no difficulties in obtaining one-month credit terms from the suppliers of the necessary construction materials.  The payment will occur in the middle of the month.

 

For this type of loan, Monash bank requires a minimum own provided capital ratio of 45%.

(1) Determine the minimum finance required for this builder and the maximum loan amount that Monash bank would lend to the builder given the bank’s current policy?  (7 marks)

(2) Provided the above information, what are the concerns of lending to this builder? ( 8 marks)

(3) Why builders are special customers for banks? (5 marks)