Pacific Grove Spice Company - Assignment Example

Name: Lecturer: Course name: Course code: Date Executive summary The company had opened up a small grocery business in Monterey peninsula in the late 1980s to sell a collection of food, coffees, teas as well as spices. The founder of the company was Judith findra who was interested in investing in Asian and Indian cuisine .The warehouse expanded so as to support the broad range of international food and within ten years of its operation, the company was known globally. Pacific Grove company intends to invest on a new project that either cost the company $11,000,000 or $13, 200, 00.This project are the new television program or acquisition of high country respectively. In both investment appraisals the company considers equity as a source of raising the capital given the capital rationing. The problem the company currently faces is which project to investment and the appropriate method of appraising a project that will give an appropriate conclusion on project viability Acquisition or disposal of an entity entails a detail understanding of both the internal and external factors affecting the business as well as the liquidity position of the company if it makes a decision to acquire another company. Where business is going to finance its project using the ordinary shares, factors such as effect of new equity finance on net income and earnings per share ought to considered as well as whether the project will generate positive net present value from investment or not. The key motive of a manager is shareholders wealth maximization and that is why performing analysis and considering the systematic and unsystematic risk affecting the company should be ascertain before making an intention of buying a company or financing a new project using the unissued ordinary share capital Introduction The company intends to appraise a new project and appreciates investment appraisal tool such as the net present value and the discounting factors in order to precisely estimates the trend in cash flows and whether the cash flow is favorable in that the net present value being positive. The general trend of the company is favorable and forecasting the return on equity depicts an increasing trend thus the liquidity position is sufficient enough in making an intent to finance a new protect using equity finance. Profitability of Grooves finial statement in relation to bank statement Return on assets= {Net income/total assets} Last three years analysis 2014 2014 2015 ROA (3.835/76.696) (4.316/85.134) (4.793/92.797) 5% 5.078% 5.16% Current ratio= {current asset/current liability} 2013 2014 2015 Current ratio (45.537/26.061) (48.36/28.826) (52.575/31.282) 1.75 1.7 1.6 The above ration analysis depicts positive trends in terms of the company’s performance. The return on asset employed is increase from 5% in the year 2013 to 5.16% by the end 2015 implying that investment will yield a return on asset employed. It can as well be depicted that the current ratio of the company beyond 1; 1.This is a strong indication of the good liquidity position of the company and therefore the company will not be affected by repayment since the business a strong market capitalization that will cater for the debt repayment eminent by the trend of the forecasted current ratio as well as the return on asset employed. Hence, projected sales growth levels bring the relevant ratios into compliance as requested by Pacific’s bank. Question two Analysis of production and sponsor the television program The company should sponsor the production of television program since; a positive net present value will be realized from investment hence a return on project investment is guaranteed. Debt to finance the project The company can take on debt to fund the project since, debt capital is always considered the cheapest source compared to equity capital and also there will be positive net present value implying that the debt can be repaid within the stipulated time frame Equity finance Impact of the equity issue on Pacific's financial ratios and existing shareholders Issue 400,000 share at $27.5= $11,000,000 EPS= (total net income/no of ordinary shareholders} Outstanding shares 2013 2014 2014 Existing share 429.7 1.2 1.2 New Shares 430.1 1.6 1.6 Total income declared and paid 2013 2014 2015 Earnings per share $1.90 1.75 2.04 New EPS $817.0/430.1) (2.1/1.6 ($2.4/1.6) New EPS 1.9 1.3 1.5 Common Shares Outstanding=1165327 New share=400,000 Total shares=1,565,327 Issuing of new shares to finance the television program will lead to a reduction in the value of earning per share and increases the profitability ratio. A reduction in the earning per share is a short term experience since; shareholders will receive a high dividend in the subsequent years (Egner 2010). Current a reduction in earnings per share is due to the fact that the company intends to raise $11,000,000 to fiancé a new project in which the turn will be realized in later years. Therefore, it can be concluded that financing a project using equity is expensive unlike the debt capital and thus accompany should fiancé its project using the mixing of debt and equity. This is due to the fact that a levered firm commands a high value with low component cost of capital which is favorable to the company in terms of yield and return. Question three Pacific Grove Spice Company Forecasted High Country Seasonings Income Statement ($ in millions)           Income Statement 7/4/2012 7/5/2013 7/6/2014 7/7/2015 7% 6% 5% 4.80% Net Sales $16.48 $16.87 $17.50 $18.41 Cost of Goods Sold 58,5% -9.64 -9.871 -10.24 -10.77 Gross Profit Margin $6.84 $7.00 $7.26 $7.64 R&D Expense (1.6%) -0.26 -0.0.27 -0.28 -0.0.29 SG&A Expense 31.5% -5.19 -5.315 -5.512 -5.798 Earnings Before Interest & Taxes $1.39 $1.69 $1.47 $1.84 Interest Expense -0.057 -0.072 -0.06 -0.063 Earnings Before Income Taxes $1.33 $1.62 $1.41 $1.78 Income Taxes -0.297 -0.273 -0.285 -0.306 Net Income $1.04 $1.34 $1.12 $1.776 Forecasted High Country Seasonings Balance Sheet ($ in millions)           Assets 06/30/12 06/30/13 06/30/14 06/30/15 Cash(20 day operating exp) $3.274 $0.687 $0.407 $0.281 Accounts Receivable(75 day of sales) 3.386 3.467 3.670 3.870 Inventories 8.240 8.560 8.944 9.440 Prepaid Expenses(1.2% of sales) 0.198 0.203 0.210 0.220 Total Current Assets 12.066 12.483 13.093 13.811 Net Property & Equipment * 15.324 17.664 17.092 17.696 Other Long-Term Assets(4.5% of sales) 0.742 0.759 0.787 0.828 Total Assets 31.406 30.906 30.972 32.335           Liabilities + Owners' Equity 06/30/08 06/30/09 06/30/10 06/30/11 Bank Notes Payable $0.791 $0.818 $0.856 $0.902 Accounts Payable(30 day cost of goods sold) 0.786 0.131 0.447 0.901 Current Portion of Long-Term Debt 0.000 0.000 0.000 0.000 Accrued Expenses(1.66% 0f sales) 0.274 0.280 0.290 0.419 Total Current Liabilities 1.851 1.23 1.593 2.222 Long-Term Debt 0.000 0.000 0.000 0.000 Total Liabilities 1.851 1.23 1.593 2.222 Common Stock(404,908*32,6) 13.200 13.200 13.200 13.200 Retained Earnings $1.04 $1.34 $1.12 $1.776 Total Shareholder Equity 15.315 15.137 15.059 15.137 Total Liabilities & Net Worth 31.406 30.907 30.972 32.335 Free cash flow= {operating cash flow-capital expenditure} Operating cash flow= (net income-depreciation & amortization changes to account receivable changes to inventory) 2012 2013 2014 2015 Total Net income 2.115 1.937 1.859 1.937 7.848 Inventory 6.180 6.418 6.708 7.080 26.386 Debtors 0.221 0,196 0.246 0 0.467 operating cash flow 8.516 8.355 8.813 9.017 34.701 Free Cash flow= (34.701-13.2] =$21.501 Therefore it can be depicted that the value of High Country's is greater than what Pacific must pay to acquire the firm Cost of acquiring high country= $13.2 million Value of High country= {free cash flow* discounting factor} Discounting factor=risk free rate + market premium (beta) K.e= {2 %+( 7%*0.85) =2.06% Value of high country= (34.701*2.06%} =71.467 {NPV) Pacific should therefore acquire High County since the company will realize profit from investment. The cost of acquiring the company is low as compared to the value of the company N.PV=cash flow*discounting factor Question four Potential acquisition from a financing standpoint consolidated Income Statement ($ in millions) Income Statement Pacific High country combined Net Sales $127.259 $18.41 $145.67 Cost of Goods Sold 97% 74.447 -10.77 63.677 Gross Profit Margin 52.813 $7.64 60.453 R&D Expense 2.036 -0.0.29 2.036 SG&A Expense 101.4% 40.087 -5.798 34.289 Earnings Before Interest & Taxes 10.690 $1.84 12.53 Interest Expense 4.124 -0.063 4.061 Earnings Before Income Taxes 6.566 $1.78 8.346 Income Taxes 1.773 -0.306 1.467 Net Income $1.561 $1.821 $3.382 \ Pacific Grove Spice Company Combined Balance Sheet ($ in millions)         Assets groove spice High country Combined Cash(20 day operating exp) $0.281 $0.28 $0.562 Accounts Receivable(75 day of sales) 3.609 3.87 7.479 Inventories 9.440 9.44 18.880 Prepaid Expenses(1.2% of sales) 0.220 0.22 0.440 Total Current Assets $13.55 $13.81 $27.36 Net Property & Equipment * 17.696 17.696 35.392 Other Long-Term Assets(4.5% of sales) 0.828 0.828 1.656 Total Assets $32.07 $32.33 $64.41 Liabilities + Owners' Equity Groove spices high country Combined Bank Notes Payable $0.902 $0.90 Accounts Payable(30 day cost of goods sold) 0.901 0.901 1.802 Current Portion of Long-Term Debt 0.000 0 0.000 Accrued Expenses(1.66% 0f sales) 0.306 0.306 1.112 Total Current Liabilities 2.109 2.109 4.718 Long-Term Debt 0.000 0 0.000 Total Liabilities 2.109 2.109 4.718 Common stock (404,908*32,6) 13.200 13.2 26.4 Net Income $1.561 $1.821 $3.382 Total Shareholder Equity 15.2 15.2 30.4 32.07 32.33 64.41 The potential advantages to pacific groove in meeting its financial needs will be met within the stipulate time frame since it is apparent that investment in high countries would lead to a positive net present value. The disadvantage is that, it will take long before the cash flow is realized from investment and hence this will put the company in a financial difficulty if proper plans are not met in order to cater for both the systematic and systematic risk as well. In general, pacific should acquire high county seasoning since there will be high return to the company inform of profit. This is depicted from the forecasted positive trend in cash flow of the company. Question five Equity issue of 400,000 shares to finance television program Issue 400,000 share at $27.5= $11,000,000 Net income $7.847 million Potential acquisition of high country Cost of acquisition cost $ 13,200 Net income=$7.484 million From the above analysis, it can be concluded that acquisition of high country will yield a return that is almost the same with the television program (Debarshi 2011). The company therefore should consider running both program since high return will be realized. Where there is capital rationing in the company, acquisition of High country will relevant since high return will be realized and capital base of the company will be expanded since the company will be having a subsidiary. Reference list Debarshi, Bhattacharyya. Management Accounting. 2011. Egner, Thomas. In strategic Analysis of a diversified company. 2010. Read More