Financial Analysis Task 3
A1. Recommend a capital structure.
Capital structure is defined as " How a firm finances its overall operations and growth by using different sources of funds."(investopedia.com). In order for Competition Bikes Inc to expand to Canada, it has to choose the best method that will maximize shareholder return. In order to do this the company has to have a capital structure that is sufficient enough to be able to increase its cash flow, pay its debts, and have a return on its investments. This method has to also offer an option that will minimize the company's overall cost while providing addition dividends to investors at the least possible risk. To determine this we will use Earnings per share from the table below to see which option is best for the company. Based on the EPS we recommended that the company pursue the option of 50% preferred stock and 50% common stock. This option offers the best balance for the company to maximize its returns and control its debt. It also provides the highest Earnings Per Share for investors while building the financial position of the company. Comparison table for Earnings per share
A1a. Justify your recommendation.
For the company to expand into Canada it needs to consider different capital acquisition methods in order to fund their expansion. An analysis of the available options is necessary in order for the company to determine the best option. This will allow the company to go forward with its plans and still allows for optimization of the company's capital. We will now analyze the 5 different methods that are available for the company to achieve the required amount of capital. The 9% Bonds option. If the company choose to go with this option, they must keep in mind the risk that is involved with bonds. This is because they are based on a payment system that requires a fixed interest payment regardless of the status of sales. This would present a negative effect on the earnings of share holders, especially if the sales they were expecting do not happen. The income of the company would also be decreased because payment are made twice per year. This This is regarded as a debt, not equity which takes more time to realize benefits. This option yields the highest interest and lowers Competition Bikes Income before Tax (EBT). The plus to this option is that bonds are debt financing and therefore tax deductible. In some smaller companies this is less expensive that using equity to finance debts. Competition Bikes does not fall into this category really because it is unknown if profits will increase or dividends will be diluted in future years. Future monies earned will be used to pay off the debts and not be reinvested into the company as new earnings. Using moderate expected earnings before interest and taxes amounts (EBIT), the EPS for stockholders over 5 years with this option is .103. The lower EPS is means less common stock shares outstanding, less equity, and fewer dividends. The risk is higher in this option as highly leveraged companies tend to have difficulties with cash flow. The 50% Preferred Stock and 50% Common Stock option. The investors fund the expansion for this option. The company's equity is used to fund the expansion rather than the use of debts. CBI's debt to income ratio will be less and the investors have more of an invested interest in the company. The Board of Directors will determine if common stockholder will receive benefits and the Preferred stockholders will receive dividend payouts on a regular basis. The stock will also be able to increase since Preferred stockholders tend to hold on to their stocks longer. The company retains all EBIT therefore there is no interest to pay back. This option also had the highest EPS of all options at .203 over five years. The return on investment will begin immediately for investors in year 9. Although this option provides the highest net income and preferred stock dividends , because of the...
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