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Case 8 - Look Before You Leverage

The document analyzes three options for how Symonds Electronics Inc. could obtain $5 million in additional funding for an expansion project: 1) 100% debt financing, 2) 100% equity financing, or 3) 50% debt and 50% equity. Option 1, obtaining 100% debt financing, is recommended because the company currently has no debt and low bankruptcy risk. Taking on debt would increase the firm's value due to the lower after-tax cost of debt compared to equity. Obtaining all funding through debt is projected to yield the highest return on equity and earnings per share.

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812 views7 pages

Case 8 - Look Before You Leverage

The document analyzes three options for how Symonds Electronics Inc. could obtain $5 million in additional funding for an expansion project: 1) 100% debt financing, 2) 100% equity financing, or 3) 50% debt and 50% equity. Option 1, obtaining 100% debt financing, is recommended because the company currently has no debt and low bankruptcy risk. Taking on debt would increase the firm's value due to the lower after-tax cost of debt compared to equity. Obtaining all funding through debt is projected to yield the highest return on equity and earnings per share.

Uploaded by

MariaAngelicaMargenApe
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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1

I. Point of View
II. Statement of the Problem
III. Objective

The objective of this case is to determine where to get the additional funding for the company's
expansion project-- whether to lend from the bank, acquire more investors, or both. We will a
calculation for each alternative course of action and determine the best choice to take.

IV. Areas of Consideration


● Symonds Electronic Inc. latest Balance Sheet

● Symonds Electronic inc. latest Income Statement

● The additional capital needed for the project which is $5,000,000


● Potential increasing revenue of 10% as worst case and 50% for best case per year.
2

● Can issue Common stock at $15 per share


● Can issue a 5-year notes at par with a rate of 10% per year.

V. Alternative Courses of Action

Option 1 Symonds Electronics Inc. is to raise capital through 100% debt. If the company
increase its sales by only 10% (worst case scenario), the company will have a net income lower
than the current net income of the company. If the company will increase its sales by 30% up it
will have a higher net income compared to the current net income despite the high rate of
interest and taxes. Same with Return on Equity and Earnings per share, increasing the sales
30% up will result to a greater ROE and EPS from the current.
3

Option 2 Symonds Electronic Inc. will raise its capital through 100% Equity financing. If the
company will choose this option for financing its capital, increasing sales by at least 10% will
generate a net income higher than the current. Profit margin will be of the same rate at 9% but
ROE and EPS will only be higher to the current if the company will increase sales by 50% up
which is the best case scenario.
4

Option 3 assumes that Symonds Electronic Inc. will get its financing through 50% Debt and 50%
Equity. Increase in sales by 30% or more will result to a higher net income compared to the
current. All profit margins are a bit below the current but ROE and EPS will increase when sales
will increase by 30% or more.
5

VI. Conclusions & Recommendations

We ​w​ould ​r​e​c​o​mm​en​d ​t​h​at t​h​e ​fi​rm ​will finance its capital through 100% Debt i​n
ord​er t​o ​r​a​ise t​h​e $5​,​000​,​0​00 fo​r ​t​h​e ex​pan​s​io​n​, ​s​inc​e ​th​e ​firm ​c​u​rr​e​ntl​y ​h​a​s ​n​o ​d​e​b​t ​an​d
i​s ​no​t ​i​n ​a​n​y i​mm​e​d​i​ate ​ri​s​k of ​bankr​up​t​c​y. ​T​h​e ex​p​e​c​te​d ​E​B​l​T ​i​s ​g​ood a​n​d ​t​h​e ​fi​rm​'​s
v​al​u​e wi​ll i​n​c​rease w​i​t​h ​t​h​e ​in​clu​s​io​n ​of​ ​d​e​bt in t​h​e ​c​ap​it​a​l ​st​ru​c​tur​e​, du​e ​to th​e ​l​ow​e​r
aft​e​r​-​t​ax c​o​st o​f d​e​b​t.
6

VII. Action Plan

Having considered all three options, our group chose to take the first option which is to acquire
all the needed additional capital through borrowing.

Though a 10% increase in sales would result to a net income lower than the current, the 10%
increase is less likely to happen. With the company's current standing and the economy's good
health, as stated in the case, the company would more likely gain more than just 10%.

Addition to that, the company has less to none debt and has minimal risk of going into
bankrupcy. Also, the acquisition of capital through debt would also result to an increase of the
firm's value, which is due to the lower after tax cost of debt.

Finally, among the three options, the first option is the one that would yield the highest return of
equity and earnings per share.

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