Ashleigh Cosmetics implements strong product placement displays along with advertisements in several high-circulation women’s magazine. One promotional aspect of Ashleigh Cosmetics is that they do not guarantee any sales and share no part of the advertising costs of their retailers. Ashleigh’s products are sold through 40 freelance agents in Canada and 180 in the United States. In North America Ashleigh’s retail base is in excess of 12,000 outlets. Possible expansion opportunities exist with a major Eastern based food chain, which has more then 500 outlets.
- Operations
All manufacturing processes of Ashleigh Cosmetics are preformed on site. During the Christmas season of 1996 production facilities had been pushed to their limits, as a result, Prowse purchased more equipment in order to meet the increased demand
- Human Resource
Ashleigh Cosmetics employed 90 full-time employees, seven senior management staff including Prowse and 23 salaried staff who report directly to him. Production facilities employ 60 non-unionized hourly employees.
- Economic Situation
Ashleigh distributes to both The United States and Canada with total sale being distributed 55% and 45% respectively. Key issues to note from a financial management perspective are the higher unemployment figure for Canada (9.4-Can 6.7-US), higher inflation in Canada (4.1-Can 1.1-US) and the lower value of the Canadian dollar ($0.75/USD).
- Risks
Several risks arise with the introduction of the new Marilyn M. lipstick product. First and foremost is the possibility that the market is not interested in a product that makes reference to a 1950’s movie actress and although interest has been shown, interest does not guarantee sales. Another risk is that the current lipstick market is over saturated and no niche market exits for the Marilyn M. product. Additionally, the possibility for others to follow Ashleigh’s strategy once Marilyn M. is unveiled could hurt projected sales figures, thereby reducing overall growth of Ashleigh Cosmetics.
Analysis
- The first alternative that Featherstone has is to go ahead and grant the $2,000,000 credit increase for Ashleigh Cosmetics without specific criteria.
- The second alternative for Featherstone is to decline Ashleigh’s application for the credit increase.
- The possible third alternative is to grant the credit increases based on future projections with positive Net Income greater then that of the previous year.
4. The last alternative that Featherstone has is to grant the additional funding to Ashleigh Cosmetics based on specific criteria.
Criteria
In any situation there are always certain criteria that must be met in order to come to a decision. The following section will describe several credit requirements necessary for Nancy Featherstone to base her decision upon.
- Strong Marketing Plan
In order to meet this criterion Ashleigh must show that significant effort is being made in order to promote their new Marilyn M. product. From information provided in the case, it is evident that a large financial outlay has been made on selling and advertising costs. Furthermore, Ashleigh is in the process of developing a color advertisement for its Marilyn M. product, which will be sent to buyers and trade magazines. This criterion has been met.
- Strong Management Team
In order for approval of the credit increase Michael Prowse must show Featherstone that they have a strong management team at Ashleigh Cosmetics. Two key facts from the case make this point evident. Firstly, Ashleigh Cosmetics is a small company comprised of only 90 employees of whom seven are senior management, therefore, the lines of communication are kept close and responsibility is not spread too thin. Secondly, Prowse is not new to the cosmetics industry and has done an excellent job of developing his company to the point where it is today, this unquestionably take skill, talent and a knowledge of the industry. Furthermore, past net income figures indicate that Ashleigh is able to produce profitable earnings. This criterion has been met.
3. Net Income in 1988 with Marilyn M. > Net Income in 1986
This criterion requires the net income of Ashleigh Cosmetics with the Marilyn M. product to be greater then the net income level of 1986. From the figures on the Income Statement in Appendix (?) it is evident that in1987 Ashleigh is unable to meet this condition, however the following year Ashleigh nearly triples the net income value of 1986 with a net income figure for 1989 of $1,890,000. It is worth noting that although Ashleigh was unable to meet this criterion for the 1987 fiscal year, consideration must be made regarding the large upfront costs necessary to launch the Marilyn M. product. Taking this fact into account and that the following year Ashleigh is well over this criterion it is reasonable to say that this condition is met.
- Inventory and Accounts Receivable enough to collateral loan
This criterion stipulates that the sum value of the Inventory balance and Accounts Receivable balance for the year must be enough to cover the loan. Focusing on these categories from the balance sheet in exhibit (?) the balance for 1987 and 1988 are $9,535 (2,511+7,024) and $11,457 (3,011+8,446), respectively, evidence that this criterion is satisfied.
- Maintain > 10% ROA
Looking on the ratio calculation in exhibit (?) it is apparent that during 1987 Ashleigh Cosmetics, with the introduction of their new Marilyn M. lipstick, are unable to meet this requirement. However, in 1988 they bounce back and reach an ROA of 13%. Much like criterion three, Ashleigh has not fully satisfied this criterion for both of its forecasted years. Rather then rashly stating that this is a fail, such a situation requires a longer period of evaluation. In terms of meeting this criterion it is a difficult decision to make. From a literal standpoint, this criterion has not been met, however taking into consideration the large upfront costs and the limited evaluation period it could be reasonable to give this criterion fifty percent met.
- Positive NPV of Ashleigh Cosmetics with Marilyn M. for 1987,88
As stated above the objective in meeting this criterion is to have a positive NPV. In the case of Ashleigh Cosmetics this is a tricky figure to calculate properly, due to the fact that information needed to calculate a discount rate used in the NPV calculation is absent. Furthermore complicating the task is that Ashleigh has sales in both the United States and Canada so use of two rates to represent this would be necessary. As a rash simplification, I have taken the liberty of using rates of 15% to discount the cash flows with the Marilyn M. product and 10% for the cash flows without the new product (exhibit(?)). The reason I have chosen 12% as the rate for the Marilyn M. cash flow is for two reasons: first it represents that the Marilyn M. project is riskier. The second reason is that a round number aids in simplifying the calculation so focus can be given of proving a point. I chose 10% for cash flows without Marilyn because I wanted a figure higher then the risk free rate for both US and Canada and yet lower then 12%. What can be noted from the calculations of the NPV’s is that a positive NPV is achieved with the Marilyn M. Product for 1987 and 88. This criterion has been met.
- Character, Capacity, Cash Flows
The final criteria are none less important then those previously listed. Under the heading of character criteria, Ashleigh must maintain good communication between themselves and Royal Bank, submitting any information deemed important to the line of credit when requested by Nancy Featherstone. As indicated in the case, this requirement appears to have been met as their account required little supervision and has met and exceeded budget targets.
The capacity criterion requires that Ashleigh must be willing to pay off their debts. Current assets must exceed current liabilities in which case this has met and surpassed in both 87 and 88.
The final criterion is similar to the NPV criterion in that Ashleigh must have positive cash flows. It is apparent that this requirement is met upon observation of the cash flow statement and although there are a few periods where negative cash flows are present other period far out-way these negative values.
Evaluation of Alternatives
The following section will evaluate each of the four previously stated alternatives, identifying the costs and benefits associated with each one from both Nancy Featherstone’s and Ashleigh Cosmetics’ perspective.
Alternative 1 – Grant credit increase without any necessary criteria.
From the perspective of Nancy Featherstone, this is a very risky approach to take when deciding on whether or not to approve a credit increase. This type of approach has no quantitative method for weeding out candidates that should not receive an increase in their credit line from those that deserve one. Furthermore, this type of strategy places Featherstone in a bad situation when a firm who has borrowed from Royal Bank is unable to pay back their loan. From Ashleigh Cosmetic’s standpoint, this alternative would be in their favour, although there would be little incentive, other then moral, to make good on their outstanding loans if they can simply apply for a credit increase and have it granted. This type of alternative may also have a negative affect on a company like Ashleigh Cosmetics in that guaranteed credit increases might persuade them to undertake riskier projects.
Alternative 2 – Do not grant the credit increase.
The benefit of following this alternative is that Royal Bank does not have to undertake an increase in amount of money payable to them by Ashleigh when loans are taken out, thereby limiting the total amount of money they could possibly lose, should Ashleigh become unable to repay their loan. For Ashleigh Cosmetics this approach presents a problem. In situations where costs are incurred to launch products, net income is significantly reduced. Without funds from Royal Bank to cover these costs Ashleigh will have to come up with alternative means of obtaining the necessary money either through issuing shares or applying for a loan with another financial institution.
Alternative 3 - Grant the credit increases based on future projections with positive Net Income greater then that of the previous year.
This approach is easy to quantify and requires focus on a single number. The problem with this alternative is that positive net income figures might miss lead the account manager into granting an increase in the credit line when such an increase should not have been allowed. Exhibit (Income statement) illustrates this point. Looking at the net income figures for 87 and 88 with and without the Marilyn M. product, the increase would have been granted without Marilyn ($680, $716), however, would not have been allowed with the Marilyn M. line following this alternative, due to the net income in 87 ($338, $1890).
Alternative 4 - Grant the additional funding to Ashleigh Cosmetics based on specific criteria.
This is the most narrowly focused alternative of the four suggested. The biggest advantage in using this type of alternative is that is offers far stricter guidelines to base Featherstone’s credit decision upon. This alternative also focuses on relevant details such as loan collateral, ROA & ROE, which the other alternatives avoid. Another feature that is significant takes into consideration the strength of the firm’s marketing strategy and management strength, both of which are key elements. This alternative also considers the fact that the first year of the Marilyn M. project would most likely be a implementation phase so rather then focusing on the net income of that year it looks at the net income of the following year. Lastly, this alternative focuses on qualitative characteristics such as the applicant’s character, capacity and cash flows.