Analysis of Thomas McGills Financing Decisions from 1990 to 2007 - Case Study Example

Name Tutor Course Date Final Case Question 1 Thomas McGill’s financing decisions from 1990 to 2007 indicate a mixer of wise and misappropriate decisions. These financial decisions implemented can be discussed in the period as follows: 1990 In this year, the price of stock was about $10 per share whereas the earnings per share per share were $1. The average selling at price earnings ratio was 18. The industry showed better growth trends as far as earning per share is concerned. The debt ration of the company was 30% whereas that of the rest of the industry was 38% The Company had an opportunity of adding its debt financing to the level of that in the rest of the industry (Berk & DeMarzo 823). The company had to increase its assets by approximately 30% from $80million to $104 million. The external funds required were $20 and there were option available. The company had three options of attaining funds: issuing commercial paper with a current interest rate of 4.25%, 5% long-term long term non-convertible bonds, and lastly sell of common stock to the net of the company $9 per share. McGill gave the advice of Star Bay Company to go for a combined action of selling common stock worth $10 million and ten million was obtained from long tern debt. This was bad advice from McGill. The company needed to increase its net assets and not to reduce it (Ehrhardt & Brigham 515). Issuing of common stock at a price of $9 was a waste to the company considering that, this was a discount since the price for common was $10. The company reduced its assets instead of increasing it. The debt ratio of the company was 30% and that of the industry was 38%. The company debt ratio was 8% less that that of the industry. The company was in a better position to borrow funds through long term as opposed to selling stock at a discount. 1992 Merger Financing Star Bay Company Cash budget The company cash budget indicates the anticipated amount of cash that is needed to finance its activities throughout the specified period. Through it the amount needed for to be borrowed to form debt financing can also be determined. The company had an alternative of a short loan debt bowing at an interest rate of 4.25% and a long term option of loan at an interest rate of 5%. The company cash budget indicates the need for debt financing. The performance of the company had improved greatly and its stock was fetching a good price in the stock market. SBC FCST (000$) Q491 Q192 Q292 Q392 Q492 Total sales 21,000 29000 44,000 51,000 54000 Less Total Purchases (22,500) (37500) (37500) (45000) (22500) Less expenditure (4,500) (3600) (4500) (4500) (5200) Deficit/excess (6,000) (12,100) 2000 1500 26300 Min. cash level 5000 5000 5000 5000 5000 Debt Financing required (11000) (17100) (3000) (3500) - 21300 The company required debt financing of about 13.3 million plus projected reserves of 6million. The total was about $19.3 million. Instead of borrowing money to pay up for the acquisition the company could also give out stock. The alternative of getting the money from an insurance company to finance for the merger was not the best option (Adair 103). The funds to finance the short term loan which was available at an interest rate of 4.25% were available. The company could go for the short loan financing. The loan term financing required a higher interest rate paid for a very long period of fifteen years. Issue of equity was the best option available to the company. 1995 In 1995, the company under advice of Thomas has the option of retiring its long term debt. The $25 million of 5% long term debt was to be retired. The issuing of $25 million $4.5% commercial paper was to be used for refunding the long term debt. It was a good idea to defer the refunding due inflationary pressures that were being experienced in the market. If the refunding could go ahead, the money needed to refunding will be higher as the inflationary pressure could push the interest rate higher. The switching from long term debt to short term debt was a good idea since the interest expanse accruing from the long term debt for an additional burden to the business. Waiting until favorable conditions for refunding were created gave the company the opportunity to avoid being affected by the inflationary pressure. 1999 The company growth needed additional financing. The stock had improved and was split into three and selling a price of $35. The earning per share had improved to $2.20 which was too much below the average price earning of the industry which was 16. The policy of retaining more earnings propelled the company to greatly reduce 44% to 35% in the year 1999, which was below the industry average of 37%. The company was in need of $15 million above the amount from retained earnings to finance the progressive growth. The company had four options to choose from. The first option involved short term debt at an interest rate of 7.5%. Interest rate of the short term loan was very high and could have created additional burden to the company (Watson & Antony, 273).The second option was long-term, non-convertible at an interest rate of 7.5%. Again this interest rate was too high and could have a long term implication on the expanses of the business. The third option which was chosen, involved long term convertibles at a 6.5% interest rate, which had an option of being converted to stock at $40 per share. This interest rate was fairly manageable and compared to the rest of options, it was the best option. The stock could be converted at $40, and compared to the prevailing stock price of $35, this was a good deal. The debt could be paid using stock if the company was unable to raise enough funds to refinance the finds borrowed through the issue of convertibles (Ross & Westerfield, 821). This was the best option chosen by the company and Thomas did well in this case. The last option of selling common stock of the company at $33 per share was not very attractive since it had an impact on the equity of the company and it could reduce it greatly. 2002 Thomas was approved to issue $25 million of nonconvertible bonds at an interest rate of 7.25%. The money received from this issue was to be used in refunding of short-term loans of equivalent amount of $25 and having a current interest rate of 6%. This was not a good move since the company was going to incur more in interest expanse while at the same time creating another debt of similar amount. This was another way of increasing interest expense. The debt owed for short term loan had a current interest rate of 6% and hence less interest expanse was being incurred. With the issuance of nonconvertible bonds, the interest expanse was going to increase and therefore reducing the profitability of the company. 2004 The NPV of the project 12.5(1.09)10 = $29.59 Million The option of financing the investment through the issue of bonds was a good option. The profit from the investment could be $29.59 million minus $20 million which give a profit of $9.58 million. If the interest expense is subtracted, there is still some money left for investment. The total return from the investment will be = $8+ &2.5 + $ 3 = 13.5 The capital outlay was payable immediately. This was a good investment project for the company and the yield from it was substantial to warrant the company of a good investment return by the end of ten years. 2007 The capital of $20 million was needed from external borrowing sources to finance the expansion. The company had an option of issuing a 25 year bond at a floating rate of three quarters of 1% above the prime rate. The prime rate was 8% and this brings the interest rate to 9%. The initiation interest impact on the company was 8.75%. The interest expense was 8.75% was fair for the company to get capital through this means. The option to finance the company through long term of fixed interest of 10% was rejected. This was a good idea for the company since the long term loan was expensive for the company. The interest expense to be paid was at a higher rate. Question 2 The decisions made by Thomas McGill were improving over time. The decisions that he made later were better as compared to those which he made at the beginning year. He gave sound financial decisions in future capital acquisition and investment activities. The first decision involved choosing the best method to attain funds for increase of the asset of the company. The combined choice of long term debt and sell of stock was not good. The company needed to increase its assets and not reduce them. The company could increase its debt financing by opting for long term loan. In 1992 the company could use short term financing since there were enough funds to finance the deal. Long term loan was chosen by Thomas despite it having a high interest rate. It only increased the operating expanses of the company. In 1995, the decision to defer refunding owing to inflationary pressure was good. The company could have been negatively affected by the refunding. Switching from long term debt to short term debt reduced the interest burden that the company had to bear for long term. In 1999, for additional financing, the company chose the best option of using long term convertibles of interest rate of 6.5% with an option of being converted to stock. The option carried less financial risk as compared to others. In 2002, Thomas did another mistake, he opted for nonconvertible bonds with higher interest rate of 7.25% as compared the long term debt to be paid, which had a lower interest rate of 6.5%. Apart from increasing the financial risk of the company, it increased the interest expense hence reducing the profitability of the company. In 2004, he did the right thing by choosing bonds for financing. The debt could be paid faster, and the company gained from the investment. In 2007, the decision to reject long term debt was good since it had interest rate of 10%. The 25 year bond had less interest rate. Consequently, the decisions by Thomas were improving over time. Question 3 George Teel must have seen that the performance of Thomas McGill was improving over time. Thomas should be given the chance to continue to work as the corporate fiancé officer of the company. The company should continue increasing external financing as well as internal financing to increase its growth. The investment activities should be increased to cope with the growth of the company in general. Although Thomas McGill showed some inconsistence in 2002, he can be given time to continue leading the finance section but with some defined targets. McGill could go for further training on financial investment in corporate finance. On average, he had shown some improvement on his decision making. Work cited Watson Denzil and Antony, Head. Corporate Finance Book and MyFinancelab Xl. 2009, New Jersey: Pearson Education, Limited, 473 Ross Stephen, A and Westerfield Jeffrey,J. Corporate Finance. 2006, Boston: McGraw- Hill/Irwin, 926 Adair Troy, Corporate Finance Demystified 2/E, 2011, London: McGraw-Hill Professional. Ehrhardt Michael, C. & Brigham, Eugene, F. Corporate Finance: A Focused Approach. 2008, New York: Cengage Learning, 680 Berk,Jonathan, B. & DeMarzo, Peter, M, Corporate finance, 2010, Melbourne: Prentice Hall, 1001. Read More