SMITH AND ASSOCIATES CASE: FINANCING ALTERNATIVES Introduction There are some factors to decide about capital structure

for a corporation. These can be divided into two groups internal factors, and external factors. Internal factors are fluctuating needs of the business, degree of risk, increasing ownership profit, operational control of the business, and future flexibility of collecting money. On the other hand, external features are general level of business activity, level of interest rate, level of stock price, availability of funds in the market, and tax policy. Smith and ssociates is the consultant of five potential clients for their floatation of rrighi, one of the partners of Smith and ssociates, recommended securities. !ob

following five financing alternatives for the five clients "ommon Stock #referred Stock $ebt with %arrants "onvertible !onds "allable $ebentures

Case Analysis It was &ary Thomas' duty to call the clients to submit the recommendations. %hile going to make phone call to one of the client, &ary found that the financing alternatives should have been matched with the clients. In this regard, best alternative has been derived from the causal relation analysis using given facts and figures on each financial option. The analysis is given in the matrix below(

Ta le !: Causal relation analysis o" "inancial alternati#es "or eac$ "ir% Su%%ary o" &ey "acts and status o" "ir% Casual relation analysis on "inancial alternati#es
A(T) Inc eed *+ ,illion now ) ) firm s will stock not go is for The best alternative is to go for debt with warrant) which can be secured by depressed now, so the

'est "inancial alternati#e

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Casual relation analysis on "inancial alternati#es

'est "inancial alternati#e

eed *- ,illion in - years igh growth rate in tri/state area ommon stocks trade over the counter tock is depressed but should rise in year to 0+ months illing to accept any type of security ew ,achinery should increase profit substantially ecently retired *2 ,illion in debt as virtually no debt remaining except short term obligations ood ,anagement Med"ord Enter*rises )eeds *06 ,illion to finance machinery for plumbing supplies & . 1 ) % S " .

issuing common stock. 3or the same

new machine which is to increase profit substantially, and as the firm has recent record to retire *2 , debt, it will be easier to get the creditors.

reason the firm will not go for convertible bonds, as these bonds can be converted option into of the the common stocks at the bondholders. The firm will not go for callable debentures, as it has no record to retire debt prior maturity. s stock is

depressed, and the firm has record to retire huge amount of debt 4*2 ,5, it will be very difficult for the firm to pay fixed dividend to the preferred stockholders. not be the So financing preferred stock should alternative here.

s management is not interested to surrender voting control to

The suitable alternative is to go for callable debentures, which needs not be secured

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Casual relation analysis on "inancial alternati#es

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"rusty ,anagement Stock price is depressed but expected to improve 7xcellent growth and profit forecast next year 8ow debt/e9uity ratio, firm has record of retiring debt prior to maturity 1etains bulk of earnings and pays low dividends ,anagement not interested to surrender voting control to outsiders

outsiders

and

also

by any specific asset, and also thinks the firm will have This control to call those if it expensive. is alternative extensively

dividends are paid very low which makes the outsiders buy option common eliminated reluctant of stock to common stocks, issuing and here:

suggested as the firm has record of retiring debt prior to maturity, which the will encourage bondholders. callable

convertible bonds are moreover stock price is depressed now which also hinders the firm to issue common stock. s dividends are low, the firm will not be able to issue preferred stocks. s there is no option to issue e9uity security, and also the debt/e9uity ratio is low, plus the firm has record to retire debt prior to maturity, there is a flexibility of collecting money for the firm. lso as the firm's growth is good, and the money is needed to finance expansion of the firm's operation, the firm should choose long term

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Casual relation analysis on "inancial alternati#es

debt for financing. $ebt with warrants can be issued for short term only needs financing, security 4less than five term debt be not years5 and expansion long this can

'est "inancial alternati#e

suggested. #lus here no information about asset against which warrant can be issued is provided. So this option is not suggested. +oltersdor" 'rot$ers) Inc )eeds *;6 ,illion to expand business 0,<== employees, *-6 ,illion in sales Trade over the counter Seeks additional stockholders, but not willing to sell stock at discount ,aximum limit of straight debt is *0= ,illion 3air management &ood growth prospects >ery good earnings Should spark investors invest 7xpansion occurs when there is a rise in overall activity in the industry. nd for expansion long term needed. "allable debentures can not be the option, as the firm is to going it is buy for not the expansion: possible firm. $ebt with warrants can be issued for short term only and expansion financing is The best possible option that has been left is issuing convertible bonds. s it is possible to convert these bonds into common stocks, and also the firm seeks additional stockholders, this option purpose. bonds can lso can serve the convertible provide

additional funding when the straight debt ?window@ may not be open.

bonds in future for the

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Casual relation analysis on "inancial alternati#es

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!anks would be willing to lend money for short term needs

needs financing, security

long this can not

term debt be

suggested. #lus here no information about asset against which warrant can be issued is provided. So this option is not suggested. "ommon stocks can not be an option, as it is sold discount available. mentioned management at discount. Massac$usetts Ener,y Syste% %ell respected by the "onvertible bonds can not be an option, as already there are interested investors, the firm should not go for the creditors. s no specific asset is mentioned here, so debt with warrant can not be suggested. 3rom the process of So only one option is left for this firm, and this is issuing common stocks. 3inancing gimmicks and chance to turn 9uick profit on would lso if goes investment buy common stocks. demand of stocks investors Sound growth Stock selling for *06 per share ,anagement would like to sell common stock at *;= or more %illing to use debt to raise *;6 ,illion, but this is second choice OT" It that is where is is the not selling

interested to sell stocks

encourage the investors to

high, the management can raise the stock price high.

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Casual relation analysis on "inancial alternati#es

'est "inancial alternati#e

3inancing on invest

gimmicks

and would

elimination,

callable

chance to turn 9uick profit investment encourage the investors to

debenture is excluded here, as this option is already selected for s ,edford 7nterprises.

there is a growth, so need to retire the bonds prior to maturity. s there is no

information about paying dividends of this firm, it is not suggested to issue preferred stock. (a,ano Industries )eeds *;= ,illion to expand operations )eeds long term money "losely held ownership reluctant to surrender control "an not issue debt without permission of bondholders and 3irst )ational !ank of #hiladelphia 1elatively low debt/e9uity ratio 1elatively high profits &ood prospects to growth Strong management with s the firm is going for expansion, it should prefer debt security. s debt can not be issued without of and the the the permission bondholders able s to the pay to So stock firm the has fixed issuing is the relatively high profit, it will dividend preferred preferred

stockholders.

financing alternative here.

3irst )ational !ank of #hiladelphia, so options of callable debentures, convertible bonds, and debt with warrant are not advised here. lso the firm is reluctant to loose the operational control, so selling

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Casual relation analysis on "inancial alternati#es

'est "inancial alternati#e

minor weakness in sales area

common stocks cannot be an option here.

Conclusion So from the discussion above it is Austified that the #T, Inc. should go for debt with warrant: the ,edford 7nterprises should go for callable debentures: issuing convertible bonds can be the option for the %oltersdorf !rothers, Inc.: the ,assachusetts 7nergy System is eligible for issuing common stocks: and lastly the #agano Industries should go for issuing preferred stocks.