A. Prepare a summary report in which you do the following:
A1. Recommend a capital structure approach that maximizes shareholder return. Capital Structure: “Capital structure is the manner in which a firm’s assets are financed; that is, the right-hand side of the balance sheet. Capital structure is normally expressed as the percentage of each type of capital used by the firm debt, preferred stock, and common equity.” (Capital Structure Decision, 2002) Capital structure is a mix of debt, preferred stock, and common stock to which Competitive Bikes will plan to finance its company. The recommendation for Competition Bikes pertaining to their capital structure is the alternative of 50% Preferred and 50% Common Stock. With reviewing the numbers and the EPS as outlined in the schedule below (exhibit 3-1) this is the best alternative to strengthen Competition Bike financial position with strong capital structure while maximizing shareholders’ value. Although a solid capital structure will maximize a shareholders value and increase the value of the company, it is also important to Competition Bikes as with any other business, is not to lose site and focus on what is also important to the consumer; which is the quality of the product and customer service. There are two component of total capital which needs to be analysis; debt capital and equity capital. Ø Debt Capital: Is long term debt such as bank loans; Debt Capital is typically more expensive form of equity therefore are compensated with a greater return. Ø Equity Capital: Stockholders’ Equity: Shareholder with equity capital take greater risk Preferred Stock
Common Stock Equity
A1a. Justify your recommendation.
Ø 50% Preferred and 50% Common Stock, has the highest EPS for the first three years and by the forth and five year the 9% bond has the highest of the two EPS with the chosen alternative close behind. But the overall best alternative with the best return to investor is 50% preferred and 50% common stock. Ø With this alternative and with the mix of common stock and preferred stock will maximize the shareholder wealth and /or maximize the market price per share. Ø Preferred stock holders will generally get a greater payout then of common stock holders and if the company needed to liquidate, preferred stock holders will get paid before common stock holders. Ø With investors in mind, both preferred stock and common stock relates to ownership in the Competition Bikes. The difference between the two is that preferred stock is less risky than common stock. Even thou preferred stock owners expect a less dividend payout then common stock owner, they are guarantee a regular dividend payment for a certain amount of time. (Stallman) A2.Discuss capital budget areas that raise concern.
Note: In your comments be sure to address your findings related to Net Present Value and Internal Rate of Return. Net Present Value: NPV is considered a “sophisticated capital budgeting technique and it has consideration for the time value of money where as the payback a technique does not. It is also determined by subtracting the initial cost of the project from the NPV with a discounted rate that equal to what Competition Bikes cost of capital.” (Gitman, 2008) NPV is compared to today dollar value to future dollar value after taking into consideration of inflation and returns into account. The formula for NPV is: Ø -C0 is the initial investment, which is a negative cash flow showing that money is going out; Ø The money going out is subtracted from the discounted sum of cash flows coming in; Ø The net present value would need to be positive in order to be considered a valuable investment. (Net Present Value)
NPV = Present value of cash inflow – initial investment
Criteria for NPV:
Ø If the NPV is greater than $0, then the Competition Bikes should move forward Ø If the NPV is less than $0, then Competition Bike should reject...