Capital Structure Management - Report Example

Table of Contents Introduction 2 Capital Structure Approach 2 Concerns related to Net Present Value & Internal Rate of Return 5 Working Capital needs 6 Decision regarding merger or acquisition 7 References 8 Introduction Capital Structure management is an aspect of business which will determine the long term success of the business as the ability of the business to manage the finances. This report will analyze the capital structure need for Competition Bikes Inc when they look to expand their business in Canada. The report will examine the capital structure which will be needed to ensure better returns for the shareholders. This will be followed by highlighting the concerns related to net present value and internal rate of return. The report will then analyze the working capital needs by looking to analyze the buy versus lease decision and finally the paper will evaluate whether Competition Bikes Inc should look towards analyzing the decision pertaining merger or acquisition. Thus, the paper will help to evaluate the capital budgeting decisions and will help to understand the decisions which need to be taken while looking to work in Canada. Capital Structure Approach The analysis of the capital structure approach will help to understand the approach which Competition Bikes Inc should undertake so that the returns for the shareholders are maximized. This will help to determine the capital structure strategy which needs to be undertaken so that better returns can be understood. Considering a situation where the business in Canada makes a profit of $75,446 it is seen that the EPS when only bonds are issued stands at 0.002 which shows a positive return for the shareholders. This is primarily due to the fact that the business has to pay interest to the bond which issued and is $72,000. In a similar manner when 50% preferred and 50% common stock is issued will result in an EPS of 0.027 which is similar when 20% bond and rest common stock is issued. An analysis of the mixture of 40% bonds and rest common stock the EPS accounts to 0.023 and is primarily due to the fact that the business has to pay interest to the bond holders which stand at 28,800. A composition of 60% bonds and rest common stock the EPS accounts to 0.017 and is primarily due to the fact that the business has to pay interest to the bond holders. Considering the situation where an income of $75,446 is made either issuing 50% preferred stock or 50% common stock can be chosen as it provides an opportunity where the gains for the stakeholder maximizes. It also ensures that the process will help the business to ensure that the stakeholders are able to maximize their gains and develop a phenomenon through which business prospers. Considering a situation where the business in Canada makes a profit of $86,122 it is seen that the EPS when only bonds are issued stands at 0.009 which shows a positive return for the shareholders. In a similar manner when 50% preferred and 50% common stock is issued will result in an EPS of 0.032 which is similar when 20% bond and rest common stock is issued. An analysis of the mixture of 40% bonds and rest common stock the EPS accounts to 0.028 and is primarily due to the fact that the business has to pay interest to the bond holders which stand at 28,800. A composition of 60% bonds and rest common stock the EPS accounts to 0.023 and is primarily due to the fact that the business has to pay interest to the bond holders. Considering the situation where an income of $86,112 is made either issuing 50% preferred stock or 50% common stock can be chosen as it provides an opportunity where the gains for the stakeholder maximizes. It also ensures that the process will help the business to ensure that the stakeholders are able to maximize their gains and develop a phenomenon through which business prospers Considering a situation where the business in Canada makes a profit of $100,386 it is seen that the EPS when only bonds are issued stands at 0.09 which shows a positive return for the shareholders. In a similar manner when 50% preferred and 50% common stock is issued will result in an EPS of 0.039. While issuing 20% bond and rest common stock is issued the EPS stands at 0.038 as the business is able to save on taxes on interest paid. An analysis of the mixture of 40% bonds and rest common stock the EPS accounts to 0.035 and is primarily due to the fact that the business has to pay interest to the bond holders. A composition of 60% bonds and rest common stock the EPS accounts to 0.031 and is primarily due to the fact that the business has to pay interest to the bond holders. Considering the situation where an income of $100,386 is made either issuing 50% preferred stock or 50% common stock can be chosen as it provides an opportunity where the gains for the stakeholder maximizes. It also ensures that the process will help the business to ensure that the stakeholders are able to maximize their gains and develop a phenomenon through which business prospers. Considering a situation where the business in Canada makes a profit of $118,088 it is seen that the EPS when only bonds are issued stands at 0.031 which shows a positive return for the shareholders. In a similar manner when 50% preferred and 50% common stock is issued will result in an EPS of 0.048. While issuing 20% bond and rest common stock is issued the EPS stands at 0.046 as the business is able to save on taxes on interest paid. An analysis of the mixture of 40% bonds and rest common stock the EPS accounts to 0.043 and is primarily due to the fact that the business has to pay interest to the bond holders. A composition of 60% bonds and rest common stock the EPS accounts to 0.040 and is primarily due to the fact that the business has to pay interest to the bond holders. Considering the situation where an income of $100,386 is made either issuing 50% preferred stock or 50% common stock can be chosen as it provides an opportunity where the gains for the stakeholder maximizes. It also ensures that the process will help the business to ensure that the stakeholders are able to maximize their gains and develop a phenomenon through which business prospers. Considering a situation where the business in Canada makes a profit of $135,632 it is seen that the EPS when only bonds are issued stands at 0.042 which shows a positive return for the shareholders. In a similar manner when 50% preferred and 50% common stock is issued will result in an EPS of 0.057. While issuing 20% bond and rest common stock is issued the EPS stands at 0.054 as the business is able to save on taxes on interest paid. An analysis of the mixture of 40% bonds and rest common stock the EPS accounts to 0.052 and is primarily due to the fact that the business has to pay interest to the bond holders. A composition of 60% bonds and rest common stock the EPS accounts to 0.049 and is primarily due to the fact that the business has to pay interest to the bond holders. Considering the situation where an income of $100,386 is made either issuing 50% preferred stock or 50% common stock can be chosen as it provides an opportunity where the gains for the stakeholder maximizes. It also ensures that the process will help the business to ensure that the stakeholders are able to maximize their gains and develop a phenomenon through which business prospers. The best option therefore before Competition Bikes Inc is to issue 50% common and 50% preferred stocks as it helps to maximize the returns and the gains for the stakeholders. Further issuing bonds would mean that it has a fixed interest which has to be paid. This could be an additional cost for the business and would have an impact on the long term performance. Choosing 50% common stock and 50% preferred stock would thereby save the business from additional cost and would help to multiply the gains for the stakeholders. Concerns related to Net Present Value & Internal Rate of Return A look at the net present value based on different estimates which consider the demand to be low as the worst case scenario and moderate demand as the best case scenario decisions regarding the investment can be made. Considering a situation of a low demand which is the worst case scenario which provides a cash flow different for all the years and is 66668 in year 9, 72725 in year 10, 78743 in year 11, 84667 in year 12 and 90532 in year 13. Using a PV factor of 10% shows that the present value of the future income becomes 573260 after working capital and salvage is added. This means that the present value of the future income comes out to be a loss of 26,740 which means that if the demand remains the same then investing in project would mean a loss for the business. The worst scenario highlights that the business will incur a loss if the situation is not as desired by the business. Considering a situation where a moderate demand which is considered as the best scenario possible which provides a cash flow different for all the years and is 69040 in year 9, 75980 in year 10, 85252 in year 11, 96757 in year 12 and 108161 in year 13. Using a PV factor of 10% shows that the present value of the future income becomes 602243 after working capital and salvage is added. This means that the present value of the future income comes out to be a profit of 2243 which means that if the demand remains the same then investing in project would mean a profit for the business. The best case scenario shows that the business is able to make a slight profit. Considering both the best and worst case scenario it is quite evident that the chances of downturn for the business to incur losses is higher compared to the profits which the business can make. This requires that the business takes its decisions wisely and doesn’t look at investing in the project as it would increase the chances of loss and reduce the chances of making profits as both the situation highlights more chances of loss and lower chance of making a profits. Considering the same from the perspective of internal rate of return shows that when the demand is low and is the worst case scenario and the cash flow is 66668 in year 9, 72725 in year 10, 78743 in year 11, 84667 in year 12 and 540532 in year 13 shows that an internal rate of return of 8.7% is achieved by the business when the business makes an investment of 600000. This shows that when the business invests in the project a return of 8.7% is achieved in a condition where the demand for the product is low in case of a worst case scenario. In a similar situation where a moderate demand which is the best case scenario the cash flow is expected for all the years and is 69040 in year 9, 75980 in year 10, 85252 in year 11, 96757 in year 12 and 558161 in year 13 an internal rate of return of 10.1% is achieved. This thereby highlights that the business is able to earn a return of 10.1% on the investment when the demand for the product is moderate. This clearly highlights that even when the demand is low the business earns a return of 8.7% but when the demand starts to increase the IRR also starts to rise and in case of a moderate demand the IRR is 10.1%. This thereby provides an opportunity where the increase in demand will have a positive impact on IRR will make the project look more feasible thereby providing an opportunity to ensure better returns. The analysis of the return based on the both the worst case and best case scenario shows slight improvement in the return as the worst case shows a return of 8.7% and the best case shows a return of 10.1%. The analysis from the perspective of the Net Present Value also shows that the worst and best case scenario doesn’t provide an opportunity to improve the return. The overall analysis highlights that the project is not feasible for investment as the gains for the business doesn’t improve whereas the chances for downside of the business is high so it is a project which needs to be avoided. Working Capital needs To deal with the working capital needs and requirements of the business has to find ways through which the working capital needs can be fulfilled. To deal with the issue of working capital the business needs to look at raining short term finance. The business can raise the short term finance through a process of bank loan, raising money from the market through the process of credit notes and reducing the level on inventories so that more finance can be managed for the working capital requirements. The process of raising short term finance should be such that it should be aimed for a short period of time and should be raised with the objectives of meeting the short term requirements. The business will further have to deal with process and mechanism through which working capital requirements can be met. The business needs to manage the funds properly by ensuring that the money from the customers are collected on time. This will reduce the chances of bad debts and will provide an opportunity through which liquidity can be maintained. This has to be matched by the fact that inventory level have to be reduced and the money to the creditors needs to be paid after collecting the money from the debtors. The overall process will help to bring a change and will provide an opportunity through which working capital requirements will be better met and will provide an opportunity to ensure liquidity. The purchase decision provides an opportunity through which liquidity can be maintained as it is seen that the principal 83089 will be paid all the year which includes the principal amount and the interest which varies and changes in each year. Looking at the cash flow after taxes which will determine the liquidity of the business shows sufficient cash flow as in year 9 it is $80,439, year 10 is $81,743, year 11 is $83,125, year 12 is $84,590 and year 13 is $86,143. This helps to highlight the fact that the liquidity of the business is strongly maintained. A look at the leasing decision while maintaining the working capital requirements shows that the cash outflows which is the same at $58,500 comes out to be $283,752 if the leasing arrangement is considered. In a similar manner considering a purchase decision where the cash flows remain as in year 9 it is $80,439, year 10 is $81,743, year 11 is $83,125, year 12 is $84,590 and year 13 is $86,143 shows the present value to be $399,744. The comparison of the two shows that the business has to pay more if the purchase decision is considered as compared to the leasing decision. The best option at the juncture would be to take the leasing decision as it will help to save around $115,992. This would also mean that the liquidity will be better in all the years and is an option which should be chosen. Choosing the leasing option would be better as it helps to ensure that the liquidity within the system improves as compared to the purchase decision. This will thereby also ensure that the process of leasing provides flexibility because if the business is not able to work properly then the business can look forward towards cancelling the leasing decision which will reduce the chances of financial loss as compared to the purchase decision which will impact the long term financing as well as the working capital requirements. Decision regarding merger or acquisition Competition Bikes Inc while looking to take decision pertaining to mergers or acquisition needs to evaluate the manner in which decision will have an impact on the long term prospect of the business. A merger situation where 975000 common stocks of Competition Bikes merge with 200000 common stocks of Canadian Biking will help to understand the manner merger decision will be taken. Further EPS for Competition Bikes is 0.032 and Canadian Biking is 0.121 having a P/E of 22 and 9 respectively demonstrate different earning per share. Before the merger the EPS of Canadian Bikes Inc is 0.032 and Canadian Biking is 0.121 which after the merger becomes 0.053. It shows that the decision of a merger is having a positive impact on the EPS of the organization and should thereby look towards taking the decision as it will have a positive impact of the share prices of Competition Bikes Inc The decision of considering a situation of an acquisition shows that having cash flows of $50,000 in year 9, $53,000 in year 10, $56,300 in year 11, $59,930 in year 12 and $63,923 in year 13 shows the present value to 212138 when a PV of 10% is considered. The offer price on the other hand is $286,000 which would mean that the business will have to spend more than they are able to gain. Comparing both the decisions shows that the better option would be to merge as it will have a positive impact on the share prices and will multiply the overall effectiveness through which the organization performs. References Read More