A. Prepare a summary report in which you do the following: A1.
Recommend a capital structure approach that maximizes shareholder return. Capital Structure: “Capital structure is the manner in which a firm’s assets are financed; that is, the right-hand side of the balance sheet. Capital structure is normally expressed as the percentage of each type of capital used by the firm debt, preferred stock, and common equity. (Capital Structure Decision, 2002) Capital structure is a mix of debt, preferred stock, and common stock to which Competitive Bikes will plan to finance its company.
The recommendation for Competition Bikes pertaining to their capital structure is the alternative of 50% Preferred and 50% Common Stock. With reviewing the numbers and the EPS as outlined in the schedule below (exhibit 3-1) this is the best alternative to strengthen Competition Bike financial position with strong capital structure while maximizing shareholders’ value.Although a solid capital structure will maximize a shareholders value and increase the value of the company, it is also important to Competition Bikes as with any other business, is not to lose site and focus on what is also important to the consumer; which is the quality of the product and customer service. There are two component of total capital which needs to be analysis; debt capital and equity capital. O Debt Capital: Is long term debt such as bank loans; Debt Capital is typically more expensive form of equity therefore are compensated with a greater return.O Equity Capital: Stockholders’ Equity: Shareholder with equity capital take greater risk Preferred Stock Common Stock Equity (Gitman, 2008) Exhibit 3-1 A1a.
Justify your recommendation. O 50% Preferred and 50% Common Stock, has the highest EPS for the first three years and by the forth and five year the 9% bond has the highest of the two EPS with the chosen alternative close behind. But the overall best alternative with the best return to investor is 50% preferred and 50% common stock. O With this alternative and with the mix of common stock and preferred stock will maximize the shareholder wealth and /or maximize the arket price per share.
O Preferred stock holders will generally get a greater payout then of common stock holders and if the company needed to liquidate, preferred stock holders will get paid before common stock holders. O With investors in mind, both preferred stock and common stock relates to ownership in the Competition Bikes. The difference between the two is that preferred stock is less risky than common stock. Even thou preferred stock owners expect a less dividend payout then common stock owner, they are guarantee a regular dividend payment for a certain amount of time. (Stallman) A2. Discuss capital budget areas that raise concern.
Note: In your comments be sure to address your findings related to Net Present Value and Internal Rate of Return. Net Present Value: NPV is considered a “sophisticated capital budgeting technique and it has consideration for the time value of money where as the payback a technique does not. It is also determined by subtracting the initial cost of the project from the NPV with a discounted rate that equal to what Competition Bikes cost of capital. ” (Gitman, 2008) NPV is compared to today dollar value to future dollar value after taking into consideration of inflation and returns into account.
The formula for NPV is: O -C0 is the initial investment, which is a negative cash flow showing that money is going out; O The money going out is subtracted from the discounted sum of cash flows coming in; O The net present value would need to be positive in order to be considered a valuable investment. (Net Present Value) NPV = Present value of cash inflow – initial investment Criteria for NPV: O If the NPV is greater than $0, then the Competition Bikes should move forward O If the NPV is less than $0, then Competition Bike should reject any movement Internal Rate of Return (IRR): IRR is more widely used over NPR. The IRR is the discount rate that equates the NPV of the investment opportunity with the $0. It is compounded annual rate of return that the company will earn if it invests in the project and receives the given cash inflows.
” (Gitman, 2008) Criteria for IRR: O If the IRR is greater than cost of capital, accept the project O If the IRR is less than cost of capital, reject the project Scenario one (low demand): 1. Total investment in the capital structure is $600,000 2. Depreciation based on 10 year life Building is expected to have $250,000 value at the end of ten years 3.Sales projections: Year 9 – 500 CarbonLite models Year 10 Year 11 – 1% growth year over year Year 12 and Year 13 – 2% growth year over year Cost of goods sold will increase proportionately 4. Selling and administrative anticipated expenses for Canadian operations: Year 9 : $250,000 Year 10 : $240,000 Year 11 : $230,000 Year 12 : $220,000 Year 15 : $210,000 Stabilization after year 5. 5.
Competition Bikes requires a 10% hurdle rate to purse a capital investment. Based on NPV: I recommend declining this project of low demand with the NPV as a negative and according to the recommended criteria.My concern with scenario one is the NPV (net present value) after five year has a negative amount of - $39,281. With the slow growth of 1% in year 10 and year 11 and then increased by only 2% growth the last two years, has proven that these sales are not aggressive enough to help make this project a profitable project within the five year time frame allotted. It could eventually become a profitable project, but it just will take a little longer due to the low projections for growth.
Based on IRR: According to the outcome in the Low Demand scenario and all the factors in mind and with an 8. % IRR, this would be considered a good project to move forward with due to the positive outcome and following the rules of the criteria as to whether or not to accept a project. I would recommend accepting the project due to the positive outcome. Scenario two (moderate demand): 1. Total investment in the capital structure is $600,000 2.
Depreciation based on 10 year life Building is expected to have $250,000 value at the end of ten years 3. Sales projections: Year 9 – 500 CarbonLite models Year 10 Year 11 – 3% growth year over year Year 12 and Year 13 – 5% growth year over yearCost of goods sold will increase proportionately: Cost to produce to increase 2% per year 4. Selling and administrative anticipated expenses for Canadian operations: Year 9 : $250,000 Year 10 : $240,000 Year 11 : $230,000 Year 12 : $220,000 Year 15 : $220,000 5. Competition Bikes requires a 10% hurdle rate to purse a capital investment. Based on NPV: I recommend accepting this project with moderate demands of increases in sales and following the NPV formula with the outcome of a +$8,447. This decision is also relating to the outlined recommended criteria of NPV.
NPV (net present value) after five year has a positive amount of +$8,447. Evaluating the moderate growth of 3% in year 10 and year 11 and then increased to 5%growth the last two years, has proven that these sales are aggressive enough Based on IRR: According to the outcome in the Moderate Demand scenario and all the factors in mind and with a 10. 4% IRR, this would be considered a good project to move forward with due to the positive outcome and following the rules of the criteria as to whether or not to accept a project. I would recommend accepting the project due to the positive outcome A3.Discuss how working capital can be properly obtained and managed for the Canadian expansion.
Working capital is how much in liquid assets a company has on hand and available. Working capital is needed to pay for any monthly expenses and any unexpected expenses that may arise during such time. Working capital is to meet the short-term obligations of the business, and to build and grow the business. (Wolfe, 2012) The way Competitive Bikes can obtain their working capital is to make their money work for them.
One way to help do this is rather than Competition Bike acquiring a new building in Toronto, the best option would be to lease the uilding from the leasing company and if at the end of five years, if Competition Bike is in a strong financial position, then they will have the option to do so at that time. But at this time and comparing the two options that were provide as to whether to buy or lease, I would recommend leasing the building. With leasing Competition Bikes will pay out less money with leasing by $12,339 and they could invest that money and collect interest and or dividends. Cash flow which is working capital is the bloodline of a business that will help keep it going forward.Competition Bikes cash flow going out needs to stay lower than cash flow coming in for it to be successful. If Competition Bikes does not excise good decisions and cash management, they may not be able to make investments later to acquire or merge with Canadian Bike Company.
“Scholars have found over the years that insufficient capital is one of the main reasons for small business failure, coupled with lack of experience, poor location, poor inventory management and over-investment in fixed assets, according to the Small Business Association. (Mansueto Ventures LLC, 2011) A4. Discuss whether Competition Bikes Inc. should merge with or acquire the Canadian Biking Inc. facility. Merge or Acquisition is the question for Competition Bikes? What is the best interest not only for the company but for the shareholders? O Merge: It is when two companies come together and become one; O Acquisition: It is when one company, usually the bigger of the two, comes in and take over the other company and the smaller of the two companies ceases to exist.
If Competition acquires Canadian Bike, its buying its market share which in turn will increase the efficiencies while decreasing the competition in Canada. They will also gather any of the Canadian Bikes technology development in their business application which will help Competitive Bike to stay competitive with the larger bike competitors. By acquiring Canadian Bike, will also allow Competition Bikes to become more visible and be allowed to reach new markets and grow more revenue than if they do not merge or acquire Canadian Bike.With a merge is may help with new sales opportunities and improve Competitive Bikes standing within new shareholder in order to raise more capital.
In looking at the number on the financial Data provided, I believe a merge would be the best choose for Competitive Bikes. Comparing the numbers on the financial data, Canadian Biking has a higher Earnings per share of double the amount of Competition Bikes with a lower buy in of $1. 35 per share. With the merge, Competition Bikes earnings per grow to .
078 which is a 2% increase in just present sales of $975,000.Canadian Bikes is estimating a 10% increase in sales over the next 5 years which would benefit Competition Bikes with a merge. An acquisition can get messing and they may lose sales if it is a hostile takeover. It’s always better to be friendly in business than hostile. With a merge there are tax benefits. It may be with what is the book value of equipment vs the purchase price of equipment and reducing the depreciation annually.
If there were tax losses with Competition Bikes, it can apply it to future income that may be from Canadian Bikes.Competition Bikes could boost the combinations of after tax earnings, by reducing the taxable income of Competition Bikes. Reviewing the Cash flow financial Date, if purchased, it would cost more out of pocket if the two companies merged by about $12,000. (Gitman, 2008) B. If you choose to use outside sources, include all in-text citations and references in APA format. References: Capital Structure Decision.
(2002). Retrieved January 18, 2011, from Harcourt, Inc: http://www. business. auburn. edu/~pagedan/ch16sol. pdf Mansueto Ventures LLC.
(2011).Retrieved January 24, 2012, from How to Manager Cash Flow: http://www. inc. com/encyclopedia/cashflow. html Gitman, L. (2008).
Principles of Managerial Finance 12th edition. Addison Wesley. Net Present Value. (n. d.
). Retrieved January 22, 2011, from Finance Formulas: http://www. financeformulas. net Stallman, C.
(n. d. ). Common Stock vs. Preferred Stock.
Retrieved January 18, 2011, from BuckInvestor. com: http://www. buckinvestor. com Wolfe, L. (2012).
What is working Capital. Retrieved January 24, 2012, from About. com Guide : http://womeninbusiness. about. com ?