High Rock Industries

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High Rock Industries

  1. 1. HIGH ROCK INDUSTRIES CASE Awa Traore, Bony Faliandri Hudi, Citra Rinanti TP. & Irwan Arfandi B. Master of Management – Gadjah Mada University
  2. 2. Brief Summary • High Rock Industries (HRI) was engaged in purchase of underdeveloped acreage which was then developed for industrial use. • HRI considered the asking price of $6 million to be most reasonable • Crawford’s financial staff assured her of an increase in HRI’s earnings before interest and taxes (EBIT) of 20 percent
  3. 3. How to get 6 million? • Debt: $6 millions of straight debentures, with a 7% coupon and a 15 year maturity. Flotation cost of $200.000. There was also the possibility of a sinking fund of $400.000 per year, although all parties thought this unlikely with regards to the existing level of interest rates and the company’s reputation. • Equity: An equity issue could be sold to the public. • Preferred stock: One-hundred-dollars per share preferred stock could be sold to net the company $93.50 per share after brokerage fees. The yield on preferred stock of equivalent quality is 8 percent.
  4. 4. THEORETICAL BACKGROUND
  5. 5. Equity Financing “ Equity financing is when you (the business owner) sell an ownership interest in your business in exchange for money. The business owner and the investor(s) shares the business and the risks that come with it” • Advantages of Equity Financing Cash flow that would have been used to repay the loan, can be used to grow the business. • Dis-Advantages of Equity Financing Loss of interest of ownership of your business and also the possible loss of complete control that can accompany a sharing of business ownership with investors.
  6. 6. Debt financing “Debt financing means taking out a loan (money that is to be paid back over a certain period of time, usually with interest)” Advantages of Debt Financing • Lending party does not gain any part of ownership of your business and your only obligation to lending party is to repay the debt • Dis-Advantages of Debt Financing The biggest dis-advantage is that the business will not have all of its cash flow available to do business. Also, the interest that is owed can be high
  7. 7. Investment Banker • Most also maintain broker/dealer operations, maintain markets for previously issued securities, and offer advisory services to investors • Unlike traditional banks, investment banks do not accept deposits from and provide loans to individuals
  8. 8. Debenture • Long-term debt instrument used by governments and large companies to obtain funds • It is defined as quot;a debt secured only by the debtor’s earning power, not by a lien on any specific asset • It is similar to a bond except the securitization conditions are different
  9. 9. Sinking Fund and Flotation Cost • What Does Sinking Fund Mean? A means of repaying funds that were borrowed through a bond issue. The issuer makes periodic payments to a trustee who retires part of the issue by purchasing the bonds in the open market • What Does Flotation Cost Mean? The costs associated with the issuance of new securities. Flotation costs include both the underwriting spread and the costs incurred by the issuing company from the offering
  10. 10. ANSWERING THE QUESTION
  11. 11. •Pattern is not a standard •Give higher EBIT FIT
  12. 12. HIGH ROCK INDUSTRIES OLD DEBT EQUITY PREFF STOCK 10.000.000 10.600.000 10.882.140 11.272.140 Revenue 5.589.300 5.589.300 5.589.300 5.589.300 Cost of sales 200.000 - - Flotation cost 400.000 - - Sinking cost - - 390.000 Brokerage fees 4.410.700 5.292.840 5.292.840 5.292.840 EBIT 2.375.000 2.795.000 2.375.000 2.375.000 Interest 2.035.700 2.497.840 2.917.840 2.917.840 Taxable income 610.710 749.352 875.352 875.352 Taxes (30%) 1.424.990 1.748.488 2.042.488 2.042.488 Profit after tax
  13. 13. HIGH ROCK INDUSTRIES BALANCE SHEET: EQUITY HIGH ROCK INDUSTRIES BALANCE SHEET DEBT Current asset 7.500.000 Current asset Net Fixed Asset 52.000.000 7.500.000 Total asset 59.500.000 Net Fixed Asset 52.000.000 Current Liabilties 500.000 Total asset Long term debt 25.000.000 59.500.000 Common stock 26.000.000 Retained Earnings 8.000.000 Current Liabilties Total liabilities and equity 59.500.000 500.000 Long term debt 31.000.000 HIGH ROCK INDUSTRIES BALANCE SHEET: PREF STOCK Common stock ($20 par) Current asset 7.110.000 20.000.000 Net Fixed Asset 52.000.000 Retained Earnings Total asset 59.110.000 8.000.000 Total liabilities and equity Current Liabilties 500.000 59.500.000 Long term debt 25.000.000 Common stock ($20) 20.000.000 Preffered Stock 5.610.000 ($93.5) Retained Earnings 8.000.000 Total liabilities and 59.110.000 equity
  14. 14. DEBT EQUITY PS CURRENT RATIO 15,0000 15,0000 14,2200 TOTAL ASSET TURNOVER 0,1782 0,1829 0,1907 DEBT RATIO 0,5294 0,4286 0,4314 ROA 0,0294 0,0343 0,0346 ROE 0,0874 0,0786 0,1021 TIE 1,8937 2,2286 2,2286 DEBT TO EQUITY RATIO 1,1250 0,7500 0,7476 So, go for the preffered stock!
  15. 15. F = Flexibility Some common quot;otherquot; considerations are: Asset structure R = Risk Floatation costs Speed I = Income Management attitudes Exposure C = Control Market valuation T = Timing O = Other
  16. 16. Net income, Profitability ratio like ROA and ROE, and debt management ratio like TIE and Debt ratio.
  17. 17. Debt/Total Asset TIE OLD 0,4758 1,8571 DEBT 0,5180 1,8937 EQUITY 0,4197 2,2286 PREF STOCK 0,4229 2,2286
  18. 18. Because of the cash drain caused by sinking-fund requirements, the financial manager might be concerned with the uncommitted earnings per share related to each financing plan
  19. 19. Back to FRICTO Speed Management attitudes Control
  20. 20. Probability estimate of the level of EBIT will be used to forecast the income, and used to compare the benefit vs the cost of alternatives
  21. 21. •Ranking of other firms bonds in the same industry for comparison •Market condition
  22. 22. •Ranking of other firms bonds in the same industry for comparison •Market condition
  23. 23. •New debt to asset: 31/59.5 = 52 %, which is lower than 55 •Give them flexibility again
  24. 24. •Flexibility, refers to the future financing options for management (Debt to Asset ratio) •As capital is raised, the choice among alternatives for raising capital in the future may be narrowed
  25. 25. •Risk and income are so interrelated they cannot be discussed separately • Higher risk demand higher return To calculate the risk Debt Ratio = Total Liabilities Total Assets Times Interest = EBIT Earned (XIE) Interest Expense Fixed Charge = EBIT + TDFC Coverage Interest + TDFC Debt Service = EBIT + DEP + TDFC + NTDFC Coverage Interest + TDFC + NTDFC/(1-tx) where: TDFC = Tax deductible fixed charges other than interest (lease payments, etc.) NTDFC = Non-tax deductible fixed charges (principal repayment, etc.)

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