Subject: Source of funding
From: JMSB consultants;
Date: March 2007
* Choosing the appropriate source of financing, between Initial public offering, long term debt or preferred shares, to raise funds for the expansion of Granite Apparel.
* Granite Apparel should use an Initial Public Offering as a source for raising funds. Analysis
Initial Public Offering
The cost of issuing common shares for your company was found by adding the following expenses (APPENDIX ONE):
Bridge Financing Rate (Annual)| 10.25%|
Amount of Bridge Financing| 50,000,000|
Period| 6 months|
Yearly Interest Cost| 2,562,500|
Lump Sum Issuance Fee| 4,000,000|
Total Issuance Costs| 6,562,500|
To issue common shares is very expensive to underwrite and there are also other related costs for a company going public. These costs can be: * More experienced accountants for financial statements issuance and high internal compliance * Auditing fees
Much of the factors are above are very difficult to quantify, but using assumptions we could have an idea of the cost over a 5 year basis to compare with preferred shares.
First, let’s find a dividend cost, hoping the company does well and we pay out a 20% dividend rate with a growth of 25% in sales from 2007 - 2012. We get a total dividend amount to be 18.82 million (APPENDIX ONE). Since dividends are not an obligation but they are a benefit for shareholder satisfaction, we have a range over a 5 year period of costs between 11.5 million and 30.4 million. These values take into consideration many assumptions (g= 8%, b = 0.80 and ROE= 10.55%)
Total 5 year dividend| 18.82 million|
Audit fee (1M per year assumption)| 5 million|
Fees/ Bridge Financing| 6.56 million|
Total| 30.380 million|
Range| 11.5 - 30.4 million |
Another factor to consider for an IPO is the decrease in control for Taylor and the current shareholders.
| Before IPO| After IPO|
Total Shares| 20,000,000| 26,000,000|
Taylor Ownership| 12,000,000| 12,000,000|
Percentage Ownership| 60%| 46.15%|
If Mr. Taylor is comfortable losing total control of his company with 46.15% ownership (where control is 50%), the IPO can be a very attractive solution.
If Mr. Taylor decides to keep full control of his company, he can either purchase himself more shares or the company could issue two types of common shares; Non-voting and voting.
Taylor Ownership| 12,000,000|
Percentage Ownership| 50%|
Total Voting Shares| 24,000,000|
Total Non Voting Shares| 2,000,000|
As seen in APPENDIX THREE, the total cost of issuing preferred shares would be $30,200,000 over 5 years.
Raised Capital| 50,000,000|
Dividend Yield| 9%|
Annual Dividend (9% * 50,000,000)| 4,500,000|
Repurchase Premium| 10%|
Face Value| 55,000,000|
Issuance Fees| 2,700,000|
5 year Dividends (4.5M x 5)| 22,500,000|
Repurchase Premium| 5,000,000|
Total Cost| 30,200,000|
Long-term debt is the second source of financing the company has the option of adopting. Metropolitan life approached Granite Apparel and was prepared to lend them 50 Million dollars at a fixed rate 2% higher than the long-term U.S treasury yield. The term of the loan was 10 years. Exhibit 6 illustrates the U.S treasury yields. Since the loan has a 10 year term, we decided to select the 10 year Risk Free rate, which is 4.56%. In total the interest rate of the loan would amount to 6.56%. In order to decide, which alternative is best suitable for the company, we must find the cost associated with borrowing. In addition, we must also add the upfront fee of 1,800,000. The upfront fee is calculated by multiplying 200,000 common shares and the stock price of 9$. We assumed that the...