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A) Boudoir’s, Inc. is a profitable, growing company but has exhausted nearly all sources of financing, because they already pledged most of their assets as collateral to support growth. Theory assumes a match of the predicted assets useful life and its financing. Therefore a leasing agreement, especially taking into consideration the low amount, matches the cost of the asset with the corresponding cash flows produced by the asset. Furthermore, financing the new building and the fixtures for the new outlet with a leasing agreement provides an additional benefit because leasing agreements do not appear on the balance sheet of a company. In addition, lease payments are deducted in the income statement since they have the character of a long-term rental contract and therefore reduce the tax burden of a company. Consequently, a leasing agreement doesn’t have any impact on the evaluation of the financial situation of a company and existing creditors so that banks or other creditors are not inclined to reduce or terminate credit lines, especially in case of a private ownership structure. Moreover, since the company is profitable, a default on the lease payment is very unlikely. A public issue doesn’t come into question because it is too costly.
B) According to Moyer et. al (1987) non-convertible preferred stock does not play a major role in financing corporations with the exception of public utilities. The average utility capital structure contains 12% of preferred stock (Moyer et. al., 1987). Timberland Power & Light have only 5% preferred stock, which is also at the lower end of the range where the SEC automatically approves the issue. 35% common equity in the capital structure is in the middle of the SEC ranges and 60% long-term debt is nearly at the upper bound of 65%. If Timberland would issue common equity or long-term debt today, those percentages would move even further towards the upper boundaries and therefore future security issues would be subject to an investigation. With the issue of preferred stock today, the percentage of long-term debt, equity and preferred stock in the capital structure would change to 58.56%, 34.16% and 7.29% respectively, heading towards the center of the ranges (appendix A). Therefore future security issues are less likely to be subject to investigation, but will receive automatic approval by the SEC, which gives the company flexibility in the future. Furthermore, a holding company tries to maintain control with a relatively low ownership stake. The issue of common stock would dilute this and require a larger stake in absolute dollar amounts by the holding. Moreover, the dividends received by the preferred stock holders are most tax-exempt (70%), and for governments tax-free, because the government cannot pay itself taxes. Often governments or other corporations hold a stake in public utilities, because they provide relatively stable cash flows and because the government would like to hold shares in companies with public importance regarding infrastructure, society and state. Utilities are definitely one of those.
C) The Ripe and Fresh Canning Company has a stable, conservative business model, which bears less risk than the technology industry. Furthermore, recently sales have increased dramatically and Ripe and Fresh Canning Company operates in five states, which diversifies their sources of revenues. They need only 550,000$ and since they have a lot of capital stuck in their 60 day receivables, the company should factor their receivables. A further sales growth would even widen the spread between receivables and payables, possibly leading to liquidity problems. The company can either pledge their receivables at a creditor as collateral or sell the receivables at a discount to a company, which specialized in collecting receivables. The factor pays Ripe and Fresh Canning Company, for example 85% of the face value of the receivables and collects those in the subsequent period. To forgo the issue of the discount the company could offer favorable terms of trade to its clients if they are willing to pay earlier than the specified 60-days period. The use of receivables does not influence the credit rating since it is not considered a loan or debt (Investopedia, 2012).
D) Piper Pickle Company operates successfully in the pickle industry. The company experienced growth in earnings, dividends and stock price by roughly 7% in the last year, compared to only 5% for the average industry, which underlines the success story. This view is also supported by the relatively higher P/E ratio (10.59 – 12.94) compared to the industry average’s P/E ratio of 10. In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. However, the P/E ratio does not always tell the whole story (Investopedia, 2012). Other factors are also important such as debt level or the liquidity of shares. The liquidity of shares are given, since Piper Pickle’s shares are traded actively on the NYSE at a current price range of 18$ - 22$. The current debt ratio of 42% is 17% higher than that of the average industry, which significantly increases the probability of financial distress. Hence, the capital structure might be suboptimal which an equity issue could enhance. This is one reason why Piper Pickle Company should offer new shares in a rights offering. A rights offering indicates that current shareholder can purchase a number of additional shares at a discounted price for a fixed period. In the viewpoint of the debt holders, it can be examined that they would gain some of the benefits, because the probability of financial distress decreases through the reduced risk and the change in the capital structure due to the equity infusion. However, the shareholders are aware of this fact, would anticipate it and therefore the company has to offer an incentive in terms of a discount. As mentioned above, the company experiences higher growth than the industry average and therefore the stock price should incorporate this and the shareholders can purchase those shares at a discounted price and would benefit from the rising stock price, too. Additionally, a rights offering is associated with lower transaction cost than a seasoned equity offering to the investing public which further leads to cost savings. Finally, the opportunity of growing its own cucumbers would lead to more efficiency while at the same time decreasing the overall risk, which would benefit both the shareholders and the debt holders.
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- Maximilian Wegener (Author)Jannes Eiben (Author), 2012, Financing alternatives 28 - Eastheimer and Company, Munich, GRIN Verlag, https://www.grin.com/document/215050