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Financing Options for Continental Carriers, Inc
One of the primary factors that determine the success of a company is its financial power and ability to carry out the planned investment plans. Taking into account the costs and benefits that come with difference financing options that are available to the company, Continental Carriers, Inc. (CCI) therefore has a number of financing options to choose from. However, every financing method preferred by the company has its benefits and associated disadvantages. It was on this ground that Continental Carriers, Inc. (CCI) management evaluated all the option financing options at their disposal. The acquisition of this company would be critical in helping the firm realize its primary objective, that is, expansion of the CCI’s routes as well as cost reduction strategy. With the merger deadline set, the ICC opted for external financial sourcing and avoiding long-term debt was prioritized. The company had the following financing options to choose from; retained earnings, issuance of common stock (3 million shares), and issuing a 10% bonds with 15 years maturity. Although CCI Inc. had three external financing alternatives to choose from (debts, retained earnings, or issuance of shares), other factors had to be taken into account. Some of these key factors include the costs involved in each option, the amount of financing risks associated with each financing alternative, and the implications on the value of the firm. For instance, it was advised that the use of debt would add considerable amount of risks to the company in terms of the long term variations of the market price of the company’s common stock. On the other hand, sale of stock was likely to dilute the stock valuation. The dilution was measured in terms of the earnings per share instead of the replacement or book value of the shares. In this case, it was realized that the post acquisition earnings would raise $34 million before the interest and taxes, but if the common stock were sold, the earnings per share would be $2.72. Therefore, the use of debt would increase the earnings per share to $3.87.
It was on this account that the entire management team and the board of directors convened a meeting aimed at exploring possible financing alternatives that would have been affordable and sufficient to meeting the financing needs of the company. These resources would be useful for expansion and acquisition of new plants by CCI. On that account, evaluation of these sources of financing was critical in order to settle for the alternative that is affordable and sustainable given the company’s debt and capital structure and policy. In order to raise extra financial resources to acquire Midland Freight, Inc., $50 million had to be generated. Given the importance of these financial resources to Continental Carriers, Inc. (CCI), it is important for the management of the company to make the right choice after evaluating the disadvantages and advantage of their financing choices.
Analysis of the Options
One of the main objectives of many companies is to attain a sustained expansion mode which can increase the value of their assets and market command in their business environment. Expansion for a company encompasses increased marketing standards, increased capitalization, acquisition and many other business expansion stimulants. The management through the various stakeholders of a company makes a considerable amount of moves through the board of directors to substantially ensure there are sustained improvement, expansion, and growth of the whole company.
The recent board of directors’ disagreements alarmed the CCI’s management, headed by Mr. John Evans, president and the treasurer of Continental Carriers, Inc. (CCI), Elizabeth Thorp, to assess the previous board arguments in order to make a preformed position in the meeting to follow. There was an earlier agreement of acquisition policy as the key to continued expansion in revenues and income, thus, the merger of CCI and Midland Freight, Inc. was eminent and with the board’s policy of avoiding long-term debt, the management realized that the fund for the acquisition would be raised from outside source. Following the three scenarios, the company could use its large amounts of retained earnings which were already supplemented with the proceeds of the 1982 stock offerings to fund the acquisition. According to Ms. Thorp, the firm would sell $50 million in bonds to a California insurance company to raise the fund, with the interest rate at 10% and a maturity of 15 years. Finally, in order to avoid major market decline of the CCI’s share market prices, new common stock could be sold to the public at $17.75 per share, leaving the net proceeds of the company at 16.75 per share after the underwriting fees and expenses. In this scenario, the acquisition would require issuance of a 3 million new shares.
Considering the scenarios, the management met with a considerable amount of arguments from the board of directors and the analysis of each scenario was comprehensively analyzed in the board meeting which followed. After disappointed market performances of the CCI’s common stock, the firm’s policy of avoiding the long-term debts became realizable to the management and thus it was felt that such a change might be justified by the anticipated stability of CCI’s future earnings. In this case, selling $50 million bonds to the California insurance company would make sense according to Ms. Thorp, considering the 10% interest rate with 15 year maturity duration. This would require a sinking fund of $2.5 million, thereby leaving a 412.5 million outstanding at maturity. This would be the best to be obtained according to Ms. Thorp although it would create some sizeable need for cash. Although the Midland acquisition received much approval at the May board meeting, the cost of the debt issue raised much alarm considering the exclusion of the annual payment to the sinking fund. Issues were raised, among which argued that the stock issue had smaller cost than the bonds since the cash outlay would be required by the bond alternatives and the $12.5 million maturity considering the CCI’s already existing lease commitments. Therefore, the use of debt would add considerable amount of risks to the company in terms of the long term variations of the market price of the company’s common stock.
On the use of retained earnings, it was argued that the company’s stock had become a ‘steal’ at $17.75 per share and the CCI’s policy of the retained earnings had built the book value of the firm to about $45 per share by 1987. According to this argument, it was realized that although the true value of the firm was known but understated since the company’s assets were considerably below their current replacement cost, there was a substantial dilution of the management efforts to control the shares at 3 million share offering. This meant that selling the common stock would gift the shareholders of the company in terms of the value held the current stockholders.
One of the interesting, but striking arguments was that the sale of stock would dilute the stock value, yes, but in essence, this dilution was measured in terms of the earnings per share instead of the replacement or book value of the shares. In this case, it was realized that the post acquisition earnings would raise $34 million before the interest and taxes, but if the common stock were sold, the earnings per share would be $2.72. Therefore, the use of debt would increase the earnings per share to $3.87.
In conclusion, management’s main focus was to make a full preview of the concerns and making logical strategic moves on them. Upon the analysis of these options, it was also realized that CCI was one of the few companies in the trucking industry which had no long term debts in their capital structures, yet it had one of the lowest retained earnings in the same industry. In this way, the possibility of considering the issuance of the preferred stock came into discussion. It was therefore important, as proposed, that CCI could also consider selling 500000 shares of the preferred stock having a dividend of $10.50 per share and a per value of $100. Notably, the focus on the sale of stocks, and other financial sources were very critical in their consequences. However, the management and therefore the board of directors would not have neglected the power of other stakeholders of the Continental Carriers, Inc. It was crucial to involve all the stakeholders of the company at some points in order to avoid regrettable consequences as argued in the May board meeting, especially on the issues involving the debts and stocks of the company.
