Financial pros and cons - Essay Example

Capital Budgeting decisions of Debt Financing vis-a-vis Equity Financing and Capital Expenditure The essay analyses the financial viability of setting up a new production plant including the financing decisions and whether Superior Living Inc. should go for an IPO. Financial Analysis of Superior Living Inc. Profitability and solvency position of a company is a direct way to understand how well a company is performing. For the purpose of analyzing let us look at the following ratios and how the company has fared: Net profit margin: The Company has been earning a healthy net profit margin which has been constantly increasing from 10.

66% in the year to 11.77% in the year 2003. Operating margin: The Company has a better operating margin in 2003 of 19.60% over the previous years. This indicates the company is very efficient in managing its operating expenses to generate revenue. Return on Capital Employed: The Company have earned handsomely for its investors as return so far on its capital employed stands at approximately 25% which is far more than the cost of capital, assuming it to be at 10%. Debt Equity ratio: This ratio identifies the solvency of the firm by measuring the leverage position of a company.

Higher the ratio the more leverage a company is and vice versa and hence higher financial risk. Superior Living Inc. has a very low debt equity ratio i.e. . Pros and cons of going public Raising money by going public indicates accepting money from investors in exchange of ownership and control of the company without the obligation of paying back the money. The company as per its convenience benefits the investors by paying dividend from time to time. This sounds like easy money for the company but the flip side is that the ownership and control over the company would be foregone for the amount invested via equity financing.

In the case of Superior Inc. the company is comfortably placed in terms of book debts. The debt equity ratio very low which means the company has not used debt to the extent it should have used. Generally the ideal debt equity ratio should be 1:2 but for Superior it’s around 1:40. Therefore, the prudent course of action for Superior Inc. is too raise capital by debt financing route which also brings in tax advantage as interest paid on debts is deductible from profits and dividend paid on equity cannot be deducted from profits.

Debt financing does not affect the ownership structure of the company; hence the control remains with the owners of the company. Pros and cons of a capital expenditure Superior Living Inc. plans to start a new production plant as part of their expansion plans. To determine the financial viability of the this capital expenditure, various capital budgeting decision tools were used which includes payback period, net present value, internal rate of return and modified internal rate of return. The cost of project is $5,000,000 over a year and cash flow would start flowing in the company only from the second year.

The expected cash inflow as a result of new production plant is expected to