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Prepare a response to Mr. Capstan from the bank in which you explain why the bank would be reluctant to extend further credit to his organization even though his organization appears to be projecting sales growth.

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Prepare a response to Mr. Capstan from the bank in which you explain why the bank would be reluctant to extend further credit to his organization even though his organization appears to be projecting sales growth.

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The primary reason for the reluctance of the bank to extend further credit to Capstan's organization is the mounting debt and huge leverage utilized by the firm to achieve higher sales. In other words, instead of pumping in equity, the company is raising debt to extend more and more credit to its buyers, thereby running into a high risk zone where there is a high possibility of default on the credits/ loans extended by the company.

Although the company is very optimistic about the sales growth prospect, it failed to realize and take into account the mounting debt on its books and increased risks due to possible loan defaults/ non payment of loans by the car buyers.

If we take a close look at the income statement, the "net interest" component has been rising due to mounting debt levels, thereby creating an increased pressure on the company to meet its regular interest obligations. If the company fails to generate sufficient liquidity via cash sales, it will fail to meet its regular interest obligations. This is a matter of big concern for the bank. The high interest cost is also the ...

Solution provided by:
Sandeep Bardia, MBA
Education
  • BCom, SGTB Khalsa College, University of Delhi
  • MBA, Rochester Institute of Technology
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