The paper 'Cash Budget of Star Bay" is a good example of a finance and accounting assignment. I would not completely disagree with the decision taken by Thomas McGill of raising the funds by issuing non-convertible bonds and equity, rather I would recommend an alternative solution of raising the funds by issuing from all the three components i. e. $10 million from the non-convertible bond, $5 million from commercial paper and the rest by selling the common stock. As we already know the industry average debt ratio is 38 and 30 of SBC, so we can increase our debt ratio by raising funds by issuing debts as the debt ratio of SBC is low as compared to the industry average.
So, if we assume that total assets of the company is $100 million as the total assets of SBC was 148 million in 1999 assuming the growth rate of 5%, at the present time the debt will be $30 million, so we can raise additional $8 to $10 million by issuing debt and it will increase the leverage of the company. As the EPS (Earning per share) is 1 and the price of the stock is $10 the total number of shares would be 6 million, so the earning would be 6 million as the EPS is 1.
As our stock is underpriced as compared to the industry average and even the cost of equity is always high as compared to the cost of debts, the equity components are low as compared to the debt component and equal to short term lending and it will not have a major impact on the EPS of the company.
The burden of the interest will also be taken care of by this pattern of funding as the interest rates are not too high even though the company’ s R& D costs were high during that period and start-up costs of the new facilities were not offset by increased revenues. Earnings per share = Total earnings/Number of shares. 1b) Quarterly cash budget for the year 1992 (000$). Particulars Quarter 1(91) Quarter 2(92) Quarter 3(92) Quarter 4(92) Opening bal of cash: 6000 -4100 -22100 -25100 Collection from debtors 21000 29000 44000 51000 Total 27000 24900 21900 25900 Less: Payments to Creditors 22500 37500 37500 45000 Expenditure 3600 4500 4500 5200 Min Requirement of cash 5000 5000 5000 5000 Closing bal -4100 -22100 -25100 -29300 As we can observe from the above cash budget that the estimate made by Thomas McGill that the Star Bar Company doesn’ t require additional funds from an external source to finance its operations internally is incorrect.
The decision taken by Thomas McGill of Cash merger and raising funds by issuing long term loan would further increase the company’ s expenditure owing to the interest and thus, increase the deficit in cash as the company already is suffering from the deficit. In the late 1990s, we already raised funds by issuing debts, which increased the debt ratio as compared to the industry average. Hence, I would recommend acquiring MHP by selling the stock worth $25 million instead of a cash merger.
The EPS of the SBC would not have a major impact if MHP is acquired by selling the company’ s stock to the MHP instead of paying cash by borrowing from an external source and increasing the deficit as shown below. The following is the Cash Budget of the Company after taking the loan. Quarterly cash budget for the year 1992 000$. Particulars Quarter 1(91) Quarter 2(92) Quarter 3(92) Quarter 4(92) Opening bal of cash: 6000 -4100 -22413 -25726 Collection from debtors 21000 29000 44000 51000 Total 27000 24900 21587 25274 Less: Payments to Creditors 22500 37500 37500 45000 Interest @ 5% 313 313 313 Expenditure 3600 4500 4500 5200 Min Requirement of cash 5000 5000 5000 5000 Closing bal -4100 -22413 -25726 -30239 Long term loan 25000 Interest @ 5 % 1250 Quarterly 313 1c) I would agree with the decision made by Thomas McGill of dropping the idea of retiring debt in the current scenario.
As in the current scenario interest rate of the commercial paper is 4.5% and that of long term debt is 5.00% and as per the opinion of analysts and Wall Street experts, the interest rate are going to increase in the near future leading to high-interest rates as compared to long term debt, which is not convincing. Even borrowing short term debt would lead to finance requirement within a year to repay the short term debt as compared to long term debt which is not required to be repaid within a year.
Even short term debts are not borrowed to repay long term debt as they are borrowed to finance day to day working capital requirement.