a. Discuss the pros and cons of option 1, and prioritize your thoughts. What are the most positive aspects of this option, and what are the biggest drawbacks?
The option 1 looks at getting a loan of 4 billion from a consortium of bankers including J.P.Morgan with whom Merit has good business relationship and has served Merit with its short term as well as long term funding requirements in the past. The pros of this option are
* The well established relationship between J.P.Morgan and Merit will facilitate ease of transactions and negotiations for the 4 billion loan. * Since the consortium of lending bankers will consist of J.P.Morgan , it could better explain the creditworthiness and credibility of Merit to the other bankers and facilitate in obtaining such a large amount of loan. * With additional funding of 4 billion being met by debt alone the ownership pattern and voting rights will remain impact. * Debt carries lower cost compared to equity.
* The tax advantage of debt can be utilized by the company to improve earnings. The higher financial leverage can give the company higher profits if return form invested 4bn gives higher returns than the cost of debt. The drawbacks of option 1 are:
* With increased reliance on debt the financial risk increases and the debt servicing burden of Merit will increase. * With increase in Debt/equity ratio cost of the loan will increase as now Merit has higher financial leverage. * This could result in chances of bankruptcy in periods of uncertainty or slowdown. * The consortium of bankers will lay down restrictive covenants which will impose restrictions on further form of funding. * There will be a lot of interference from the bankers in the form of periodic assessments and financial disclosures such as periodic cash flows and financial statements. * This could create agency problems as there will be conflict of interest between the stakeholders, management and the lenders.
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