Case Study IV Jack Defoe Inc.001

Sebastian Siebel-Achenbach 29 October 2018
ARBUS200 – CASE STUDY IV
JACK DEFOE, INC.
John Davidge’s problem (see the interbranch memo below) is that Jack Defoe has written
cheques for an amount exceeding the money Jack Defoe, Inc. has in its bank account plus the
maximum credit line John has the authority to approve. John honoured those cheques, placing
him in a precarious position with his superior. With Jack out of the country, John’s other choice
was to refuse to honour the cheques, which could have brought down the firm. In placing John
Davidge in this distressing position, Jack Defoe has demonstrated either a lack of business
ethics or a lack of management competence.
In making a lending decision, a banker normally considers four factors that we call the Four Cs.
These are Capacity to repay, Collateral, Character of the borrower, and business Conditions. A
bank normally borrows the money it lends from depositors and purchasers of guaranteed
investment certificates, which are similar to bonds. It then lends this money to borrowers such
as Jack Defoe, Inc. The bank has very little spread between the borrowing and lending rates,
traditionally about three percentage points. Thus it can afford very little risk and must be
comfortable with each one of the Four Cs. Three out of four is not good enough. Following are
explanations of the meaning of the Four Cs.
Capacity to Repay. This refers to the ability of the borrower to generate cash flows
sufficient to pay the interest on the loan and to also repay the principal in a reasonable time
frame.
Collateral. This refers to the amount and quality of the assets the bank takes
as collateral. The collateral can be seized by the bank and sold to recover the interest and
principal of the loan if the loan fails. Having to collect on a loan by resorting to seizing assets of
the borrower is considered a failed loan from the bank’s point of view, and would only be done
as a last resort.
Character of the borrower. This refers to the credit record, demonstrated business acumen
and other personal traits of the person responsible for the interest payments and the loan
repayment, in this case Jack Defoe.
Business Conditions. This refers to the nature and prospects of the business borrowing
the money. The key question is, “Is this a business area in which the bank wants to have its
money? Will this business sector thrive and grow?”
Use these criteria in your evaluation of Jack Defoe, Inc.

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Bank Interbranch Memo
From: Don James, Loans Manager

Sent: Friday, December 19, 2008 – 2:44 p.m.
To: John Davidge, Branch Manager
Subject: Jack Defoe Inc.
Hello John:
This account has been outstanding for three years without repayment and has grown in the past
year from $6,300 to $27,840 (including overdraft). This account exceeds your $25,000
discretionary limit and must be referred to your Loans Supervisor.
Please forward your file along with your analysis and recommendations on this account.
Don
Background (abstracted from file)
Jack Defoe Inc. is a small business manufacturing components for computer monitors. The
process and production equipment are highly specialised and were developed by the president
and principle shareholder, Jack Defoe. Product quality is reputedly high and the product
commands a premium price.
Despite the premium price, the company has been expanding sales rapidly. It has a significant
market share in North America. Jack Defoe spent time in Europe and Japan this past year and
is enthusiastic about export opportunities beyond North America. He has received token orders.
Until the beginning of 2008, production was carried out in a large double garage. Commencing
about April 1, operations were moved to rented premises in an industrial park. Reason for the
move was insufficient space. At that time most of the fixed assets were replaced because the
old assets could not meet the required production levels. The Company sold the excess fixed
assets for $4,500.
Jack Defoe owns 1,500 shares in Jack Defoe Inc. He is 32 years old and is trained as an
engineering technician. He is married with three children. Substantially all his personal
resources are invested in the business. His wife owns the family home, which is heavily
mortgaged.
Mrs. Anne Defoe, Jack’s mother, owns 500 shares in Jack Defoe Inc. acquired in 2008 in
exchange for a note payable of $18,000. This is believed to be a substantial part of her
personal resources. The conversion was made at our request.
At total of $3,000 in dividends were paid in 2008, to give Mrs. Anne Defoe a small return on her
investment. No dividends were paid in 2006 or 2007.
Jack Defoe is in Japan at this time and cannot be reached before this analysis is due.
REQUIRED: Prepare your analysis, including statements of changes in financial position.

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Sebastian Siebel-Achenbach 29 October 2018

ARBUS200 – CASE STUDY IV

JACK DEFOE, INC.

Use these criteria in your evaluation of Jack Defoe, Inc.

Bank Interbranch Memo

From: Don James, Loans Manager

Background (abstracted from file)

REQUIRED: Prepare your analysis, including statements of changes in financial position.

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