S & S Air Case Study Essay
Case Study: S & S Air’s Mortgage 3001-3 FNCE Financial Management Week 4 William Jones October 9th, 2012 Case Study: S & S Air’s Mortgage Background: S&S Air manufactures light aircraft. The owners of S & S Air, Mark Sexton and Todd Story, were impressed by the work Chris had done on financial planning. By using Chris’s analysis and looking at the demand for light aircraft, they decided that their existing fabrication equipment was sufficient, but that it was time to acquire a bigger manufacturing facility (Ross, Westerfield, & Jordan, 2011, p. 161).
Rather than building a new facility they have found a suitable building for renovation at an estimated expense of $22 million dollars. Mark and Todd have met with their loan officer, Christie Vaughn, who has given them information on various types of loan and payment structures. Here is a table showing those options: TermRateFrequencyPayment Amount 30 Years6. 10%Monthly $ 133,318. 85 30 Years6. 10%Bi-Weekly $ 66,659. 43 20 Years6. 10%Monthly $ 158,886. 65 5 Year Balloon6. 10%Monthly $ 133,318. 85 10 Year IO3. 50%Monthly $ 203,630. 37
Satisfied with the options provided to them by the bank, Mark and Todd have asked Chris to answer several questions to help them choose the correct mortgage (Ross, Westerfield, & Jordan, 2011, p. 161). The answers to these questions are provided in the addendum for review as well as the accompanying financial computations. Identify what you believe to be the key issues: There are several issues that Mark and Todd need to consider before moving forward with this project. The first issue that needs to be addressed is whether or not Mark and Todd have reviewed S & S Air’s financial statements.
The information provided by Chris in the text is limited, as no financial statements for the company have been provided. Chris’s ability to assess the liquidity of the business, identify possible collateral for the loan, form an accurate basis for comfortable monthly payments, and anticipate changes in monthly income and expenses are all a bit of a mystery. Chris has likely provided this to Mark and Todd in the financial analysis he performed, but the facts can only be assumed at this point. The second issue that needs to be addressed is whether or not a proper market analysis has been completed.
We must assume that Christie and First United National Bank have completed their due diligence on this matter. Fraser and Ormiston (2010, p. 181) state “A creditor is ultimately concerned with the ability of an existing or prospective borrower to make interest and principal payments on borrowed funds. ” The text states that the bank is willing to forgo closing cost on the loan because of the “previous” relationship. One could argue that no bank is going to provide $20,000,000 with a variety of loan options and forgo closing costs if they do not have confidence in the ability of a firm to pay.
Identify the elements of critical thinking and decision making that came into play: Concerning the first key issue of reviewing the financial statements, Mark and Todd must feel confident in what they see in the analysis. The bullet loan and interest-only loan present high risk options for S & S Air. Either option will require S& S to go back and negotiate terms with a lender. If S & S Air loses market share, it could be devastating for the business. Mark and Todd should be looking at how well their firm has performed and what areas of the business have contributed to their success.
Mark and Todd need to determine if the light aircraft market will provide enough cash flow to offset the payment option they choose. Mark and Todd should focus on the long-term financing options that allow them to pay principal and interest in a way that keeps their company financially stable. Once they understand where and how their cash flows, they can make a decision on what loan option is right for S & S Air clear. Identify your assessment of what might have been done to change the situation to a positive outcome, if necessary:
Mark seems very concerned about the interest the company is paying for each loan option. Mark and Todd should consider the monthly payment and the ability of the company to repay the loan. If S & S Air can afford to pay a higher payment, they can pay down the principal faster. Assuming the bank will not charge a fee for an early payoff; S & S could save money and avoid the risk associated with the balloon payment option or interest-only loan. By taking the 20 year loan option and making additional principal payments to decrease the interest owed, S & S could pay off a 20 year loan in 158 months.
The following table illustrates the option presented above: If Mark and Todd choose this option, they could budget accordingly each month. If they are struggling they could forgo the additional principal payment during any given month. By choosing this option, S & S Air could save money and have flexibility in the mortgage payments. References Calculatoredge. (n. d. ). Retrieved November 3, 2012, from http://www. calculatoredge. com/finance/biweekly. htm Fraser, L. M. , & Ormiston, A. (201). Understanding financial statements (9th ed. ).
Upper Saddle River, NJ: Prentice Hall. Ross, S. A. , Westerfield, R. W. , & Jordan, B. D. (Eds. ). (2011). Essentials of corporate finance (7th ed. , Rev. ). New York, NY: McGraw-Hill Irwin. Addendum Discussion Problems and Calculations Question #1: What are the monthly payments for a 30-year traditional mortgage? What are the payments for a 20-year traditional mortgage? Answer: Monthly Payments for a 30 Year Traditional Mortgage Loan Amount – $22,000,000. 00 Interest Rate – 6. 1% Term – 30 Years or 360 Months Monthly Payment – $133,318. 85
Monthly Payments for a 20 Year Traditional Mortgage Loan Amount – $22,000,000. 00 Interest Rate – 6. 1% Term – 20 Years or 240 Months Monthly Payment – $158,886. 65 (Calculatoredge, n. d. ) Question #2: Prepare an amortization table for the first six months of the traditional 30-year mortgage. How much of the first payment goes towards principal? Answer: $21,485. 52 Loan Amount$22,000,000. 00 Interest Rate0. 061 Loan Term30 Yearsor 360 Payments Loan Payment Monthly $ 133,318. 85 Amortization Table: MonthBeginningTotalInterestPrincipalEnding
BalancePaymentPaidPaidBalance 1 $22,000,000. 00 $ 133,318. 85 $ 111,833. 33 $ 21,485. 52 $21,978,514. 48 2 $21,978,514. 48 $ 133,318. 85 $ 111,724. 12 $ 21,594. 73 $21,956,919. 75 3 $21,956,919. 75 $ 133,318. 85 $ 111,614. 34 $ 21,704. 51 $21,935,215. 24 4 $21,935,215. 24 $ 133,318. 85 $ 111,504. 01 $ 21,814. 84 $21,913,400. 40 5 $21,913,400. 40 $ 133,318. 85 $ 111,393. 12 $ 21,925. 73 $21,891,474. 67 6 $21,891,474. 67 $ 133,318. 85 $ 111,281. 66 $ 22,037. 19 $21,869,437. 48
Question #3: How long would it take for S&S Air to pay off the smart loan assuming 30-year traditional mortgage payments? Why is this shorter than the time needed to pay off the traditional mortgage? How much interest would the company save? Answer: 293. 6 months. The term is shorter for two reasons. The borrower is paying biweekly instead of monthly. 52weeks/2 = 26. So the borrower will pay $66,659. 43 or 133,318. 85 the equivalent of 14 months in a single year. The second reason in the amount of principal is being paid down more quickly reducing the interests owed. Calculatoredge, n. d. ) Question #4: Assume S&S Air takes out a bullet loan under the terms described. What are the payments on the loan? Answer: Loan Amount – $22,000,000. 00 Interest Rate – 6. 1% Term – 5 Year w/Balloon Payment Monthly Payment – $133,318. 85 for 5 Years or 60 Months Final Balloon Payment – $20,497,095. 84 (Calculatoredge, n. d. ) Question #5: What are the payments for the interest-only loan? Answer: Loan Amount – $22,000,000. 00 Interest Rate – 3. 5% Term – 10 Years or 120 Months Monthly Interest Payment – $203,630. 37
Total Interest Paid – $4,432,015. 14 Total Loan Value Repaid: 26,432,015. 34 Question #6: Which mortgage is the best for the company? Are there any potential risks in this action? Answer: From the standpoint of least amount of interest paid the interest only loan is the best option. S & S Air will pay the least amount of total dollars back to the bank to borrow the initial $22,000,000. However, the monthly payment is also quite large and the company will need to have a strategy to repay the $22,000,000 of principal at the end of the 10 year period.