W6 FINANCING PLANS ANALYSIS ACTIVITY
Instructions:-
W6 FINANCING PLANS ANALYSIS ACTIVITY
ASSIGNMENT INSTRUCTIONS
Develop a response to the prompts below related to the concepts and topics covered in this week (200-300 words total for all parts of the discussion question).
Based on the scenario below, prepare an analysis of the alternatives for the board members to consider.
Blazer Technology Ltd. is a family owned company that believes it can earn an additional annual $800k profit (before interest and taxes) by expanding its range of products. In order to achieve this growth, $4m needs to be raised by the family. The board of directors has a strong preference to retain family control over the business, and is considering issuing securities to outsiders.
Three financing plans are under consideration:
Borrow the money at 11% over 5 years;
Issue 100,000 ordinary shares at $40 each;
Issue 40,000 non-voting preference shares at $100, with each share entitled to an annual preference dividend of $8.80.
Blazer presently has 500,000 ordinary shares issued. All three plans will raise the required $4m. Assume the income tax rate is 30%
Solution
W6 FINANCING PLANS ANALYSIS ACTIVITY
With prospects of earning an extra $800,000 before interest and tax, Blazer Technology Ltd seeks to raise $4m. It has three options available; borrow the required amount at 11% over 5 years; Issue 100,000 ordinary shares at $40 or issue 40,000 preference shares at $100. This paper evaluates all the three options with the goal of advising on the best option.
Option 1: Borrow the money at 11% over 5 years
Annual interest is calculated as 11%* 4,000,000
=$ 440,000
Starting with annual profit of $800,000
Less loan interest = $440,000
Net profit before tax = $360,000
Less tax at 30% = ($108,000)
Net profit = $252,000
Option 2: Issue 100,000 ordinary shares at $40
The company has a total of 500,000 issued shares. Issuing additional 100,000 shares would bring its total issued shares to 600,000. The new issue therefore represents 17% of the total issued shares. While this is not a controlling stake, it has voting power and may have their representation in the management of the company which is against the company desires. Additionally, they will be entitled to dividends in the company on all earnings for the lifetime of the company which would be expensive.
Option 3: Issue 40,000 preference shares at a dividend of $8.8 per share
Annual dividend payments = $8.8 * 40,000
= $ 352,000
Starting from an annual profit of $ 800,000
Less tax at 30% = $240,000
Net profit after tax = $560,000
Less preference dividends = $352,000
Net profit attributable to equity owners $208,000
Recommendation
The financial method that yields the highest amount of returns without diluting the owners equity is Borrow the money at 11% over 5 years as it results in net earnings of $252,000 which is higher than the others as shown above.
