Admn1017w17 Finance Problems Set 11 After Seeing The Tremend

Admn1017w17 Finance Problems Set 11after Seeing The Tremendous

Admn1017w17 Finance Problems – Set #.) After seeing the tremendous popularity of the Ziptrek zipline in Vancouver during the Winter Olympics, a Toronto company is planning to build a similar attraction. $12,000,000 in new capital will be required. Currently, the financial structure of the company includes: $3,000,000 of 6% bonds, $5,000,000 of 7% cumulative preferred stock, 3 million shares of common stock at a book value of $12,000,000, and retained earnings of $900,000. The following three alternatives can be used to provide the $12,000,000 required for the project:

  • i) $8 million in 5.5% bonds and $4 million in common stock at $12.50/share
  • ii) $10 million in 5.6% bonds and $2 million in 7.5% cumulative preferred stock
  • iii) $12 million in 5.7% bonds

The company has forecasted earnings before taxes for 2010 of $4,000,000. The firm’s tax rate is 50%. Which alternative should they choose and why?

Prepare a cash budget for Champion Limited for the months of June, July, and August 2010. The firm wishes to maintain, at all times, a minimum cash balance of $55,000. Determine whether or not borrowing will be necessary during the period and, if it is, when and for how much. Also, assume that any excess cash balances at month-end will be used to pay down any borrowing from previous months. As of May 31, the firm had a cash balance of $62,000.

Actual Sales:

  • April: $80,000
  • May: $140,000
  • Forecasted Sales:
  • June: $50,000
  • July: $39,000
  • August: $60,000

Accounts Receivable: All sales are made on account. 60% of accounts receivable are collected in the month of sale, 30% in the next month, and 10% in the following month.

Purchases: 40% of each month’s sales, with 50% paid in the month of purchase, 30% in the following month, and 20% in the following month.

Proceeds from sale of property: $25,000 cash sale received in July.

Selling and administrative expenses: $14,000 per month.

Interest payments on long-term debt: $20,000 due to be paid on July 15.

Dividends: $4,000 paid on August 3.

Capital expenditures for new equipment: $60,000 in June, $20,000 in August.

Taxes: $2,000 due in July.

Paper For Above instruction

The decision-making process regarding capital structure is critical for companies seeking to optimize their weighted average cost of capital (WACC) and maximize shareholder value. In this context, the Toronto-based company evaluating three alternative financing options illustrates the importance of analyzing the implications of different funding strategies, particularly through their impact on earnings, cost of capital, and overall financial health.

Analysis of the alternatives revolves around their relative costs, leverage implications, and the effect on the company's earnings after tax. The first option involves issuing $8 million in 5.5% bonds and raising $4 million through common equity at $12.50 per share. The second involves $10 million in 5.6% bonds and $2 million through 7.5% preferred stock. The third option entails issuing $12 million in bonds at 5.7% interest rate. The forecasted pre-tax earnings of $4 million and a tax rate of 50% provide a basis for evaluating the net income and the effect of each capital structure on earnings per share (EPS).

Option one, with a mix of debt and equity, benefits from the relatively low interest rate on bonds. The after-tax cost of debt (ATCOD) for this option is calculated as 5.5% × (1 - 0.50) = 2.75%. Equity financing, at a price of $12.50 per share, would involve issuing new shares, which could dilute existing earnings but provides non-interest bearing capital. However, the impact on EPS and leverage ratios must be carefully assessed.

Option two, with a higher-cost preferred stock at 7.5%, entails a fixed dividend of 7.5% of $2 million, i.e., $150,000 annually. Since preferred dividends are not tax-deductible, the after-tax cost remains at 7.5%. The combination of bonds and preferred stock may influence the firm's leverage and risk profile differently compared to an all-debt scenario.

Option three involves issuing $12 million in bonds at an interest rate of 5.7%, representing the lowest interest expense among the options. The after-tax cost of debt here is 2.85% (5.7% × (1 - 0.50)). The overall impact of high leverage on the company's financial risk, cost of capital, and earnings variability must be examined thoroughly.

To determine the best alternative, the company should analyze the weighted average cost of capital (WACC), projected post-tax earnings, and the overall impact on shareholder returns. Assuming the company's earnings are sufficient to service debt and preferred dividends comfortably, the approach that minimizes WACC while maintaining financial flexibility would generally be preferred. The lowest after-tax interest expense combined with acceptable equity dilution might make the third option most favorable; however, this depends also on the company's risk appetite and market conditions.

In addition to financing considerations, the cash budget forecast for Champion Limited reveals the company's liquidity position over the summer months. Maintaining a minimum cash balance of $55,000 is vital for operational stability. The forecasted sales, collections, purchases, expenses, property sales, and capital expenditures are all input variables influencing cash inflows and outflows.

The collection of receivables, based on a structured percentage of sales from current and previous months, allows precise estimation of monthly cash receipts. Similarly, purchases are planned with specified payment terms, and expenses are relatively consistent, barring one-time items like property sales and capital expenditures.

In June, the firm is expected to generate substantial cash inflow from sales and receivables, offset by significant purchases and capital expenditures. The firm must evaluate whether the net cash position dips below $55,000, prompting borrowing needs. If excess cash accumulates at month-end, it will be used to reduce previous borrowings, favoring a leaner debt profile. July's cash inflows from receivables, property sale, and sales, combined with expenditures such as interest and taxes, necessitate careful cash flow analysis to determine potential borrowing of funds to meet the minimum cash threshold. August presents similar considerations with additional capital expenditures and dividend payments.

Strategic management of cash flow through precise budgeting enables the company to avoid unnecessary borrowing, reduce interest costs, and optimize liquidity. Proper planning assists in ensuring operational continuity while minimizing financial costs. This holistic approach to analyzing capital structure and managing cash flow exemplifies sound financial management practices that contribute to long-term organizational success.

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