Pacific Grove Spice Company's The case solution
Bank Agreement and this impact on firm Strategy
Banks are facing a strong pressure after the economic crisis in the year of 2008. Banks are expanding down on high risk lenders to limit the disclosure of losses on potential loan. Fiscal year 2011, Pacific Grove had developed a vital amount of debt is $37.172 million which is why the bank is trying that Pacific decrease its interest debt to lesser than 55% of total assets and equity multiplier to be lesser than 2.7 times by June 2012 otherwise the bank will not be capable to increase any extra credit. According to Pacific’s present equity multiplier, almost 30% of its owner’s equity is funded through assets and 70% is funded through debt which is higher. According to Pacific’s high amounts of equity that are financed by debt, it should attempt to comply with the bank’s covenants in order to finance its growth otherwise without external funding it may have to consider liquidating its assets to remain flooded. According to the Pacific’s foretasted financial statements, although it can be seen that Pacific’s operations are profitable this does not indicate whether it can pay off its debts in time to meet the Bank’s agreements which is why the interest coverage ratio was also occupied into consideration. As of June 2012 Pacific’s interest coverage ratio will raises to 2.42 while its equity multiplier will only reduce to 3.3 that Pacific’s profitable operations will not be adequate to observe with the bank’s agreements. Additionally this also means that 61% of its total assets would still remain as debt. Therefore based on Pacific’s foretasted financial statements it will not be able to comply with the bank’s covenants not until at least June 2015 which means that Pacific needs to find a new to ration out its present credit loan until they catch a new source of outside funding.
(Situation 3)
Since Pacific will not be able to comply with the bank’s agreements, it needs to find a new source of external funding to fund it assets to support its rapid growth in sales. One possible option to decrease its debt is to produce and sponsor a TV show on a cooking network which could prove to have a significant positive impact; it can increase Pacific’s sales at an annual rate of 5% and needs a minimal upfront investment of $1.44 million.
According to Exhibit three which presents the capital budgeting of this prospect, it could be happen that this project will produce a positive IRR of 41.28% meaning that this could be a profitable investment for Pacific Grove, however the WACC for pacific must also be taken into consideration. If Pacific’s WACC is 10% then the expected NPV of the project would be approximately $3.27 million. Even if the WACC were to increase to 20% or 30%, the NPV of the project would still be positive which indicated that this project should generate positive cash flows. However while that may be the case, the project will still not be generating enough to comply with the bank’s agreements as evident by its equity multiplier which can be seen to decline only to 3.2 by June 2012. There is a little difference between in Pacific’s equity multiplier must chose to invest in the TV show opportunity against not investing in it.
(Situation 4)
Another alternative of Pacific is issuing 400,000 not unusual place stocks to a specific funding organization with internet proceeds of $11,000,000 because the stocks are being offered at discount. This movement could lessen the business enterprise’s degree of debt, whilst producing enough funds to finance its increase in sales. It could attain the requirement in 2012 with a 52.38$ degree and fairness multiplier because of coins injection from the proportion issuing. The 2d state of affairs is that the business enterprise uses the coins injection to retire its long-time period debt and the end result is extra enough with 43.58% and 2.15. However, a decrease debt degree can have an effect on the business firm's profitability; therefore, the business firm should examine similarly debt/fairness percentage to maximize its profit. For example, the business firm can use $five million to invest and $6 million to retire a few long-time period debts, which could now no longer handiest allow the business firm to attain its debt degree requirement however could additionally permit it to have more money for funding. Despite all of the benefits, this selection additionally consists of numerous drawbacks. The first one is the dilution of ownership; the proportion preserving of the funding organization could be better than the preserving of Founder and Peterson, which could deliver them properly to participate in board balloting in addition to control selection making. However, it may additionally lead closer to a lower EPS. In addition to which, whilst the business firm similarly troubles proportion; it might ship fake poor alerts to outsiders, that the business firm isn't doing properly and will turn out to be dropping investors’ confidence, which may lower its proportion price.
(Situation 5)
The remaining alternative is to enlarge the commercial firm through the purchase of a small successful organization “High Country Seasonings” with the shape of not ordinary place stocks, with the sale fee of $ 13.2 million, ensuing in 404,902 stocks on the contemporary fee of $ 32.60 in line with share. Despite the truth that it has the equal strength of difficulty with the different alternatives; it might nevertheless be a higher alternative because it places the organization at the location in which it can boom its profitability with inside the future. High-Country Seasonings (HCS) became supplying blessings with inside the shape of growing sale and it became additionally protective Pacific from the worst scenario of getting long time debt, as HCS didn’t have any long-time period debt (Exhibit 3). After consolidating the spreadsheet and earnings assertion of each company, it may be concluded that each debt-to-asset ratio and fairness necessities had been met, and the profitability is anticipated to have an improvement. This alternative became, in addition, analyzed the usage of the discounted cash flow method, to make certain that the organization isn't always overpriced. As the firm’s price is 25.93; it isn't always over-priced. Hence, this acquisition may want to show be a terrific preference for Pacific. However, it's far vital to deal with the dilution difficulty (Exhibit 4)....................
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