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Value of the company with or without expansion

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From Corporate Finance 9/e (Ross, Westerfield, Jaffe) pg 552

Company plans to expand in one year.

Has outstanding bond with face value of $34 million due in one year.
Bond covenants prohibit issuance of additional debt.
Expansion will be equity financed at cost of $8.4 million.

State of comapny in three states if economy with or without expansion:

Economic growth probability with expansion without expansion

low .30 $30,000,000 $33,000,000

normal .50 35,000,000 46,000,000

high .20 51,000,000 64,000,000


1. Expected value of company in one year, with and without expansion

2. expected value of debt in one year, with and without expansion

3. in one year how much value creation from expansion?
how much for stockholder? Bondholder?

4. if company does not expand, what happens to price of bonds?
what happens to price if they do expand?

5. if no expansion, what are implications for future borrowing needs?
what are implications if it does expand?

6. How would answer be affected if expansion were financed with cash
on hand instead of new equity?

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Solution Preview

See the attached file. Thanks

mckenzie corporation's corporate structuring

Company plans to expand in one year. 

Has outstanding bond with face value of $34 million due in one year. 
Bond covenants prohibit issuance of additional debt. 
Expansion will be equity financed at cost of $8.4 million. 

State of company in three states if economy with or without expansion: 

Economic Growth Probability With Expansion Without Expansion

Low 0.3 $30,000,000 $33,000,000
Normal 0.5 $35,000,000 $46,000,000
High 0.2 $51,000,000 $64,000,000


1. Expected value of company in one year, with and without expansion 
With Expansion Without Expansion
Expected value $36,700,000 $45,700,000 ...

Solution Summary

This post has multiple problems. It shows how to calculate expected value of company and debt , with and without expansion and how much value creation from expansion, for stockholder and Bondholder. It discusses about price of bonds etc.

See Also This Related BrainMass Solution

Managerial Finance - Silla Soft Drinks

The coursework is attached. Can I please have the references as well as the spreadsheet with calculation.

Silla Soft Drinks is an independent soft drinks company with a tradition of producing premium soft drinks and giving dependable quality and service, having been manufacturing soft drinks for over 100 years, and spring waters since 1993. The proud boast of the company is that their success has been based on the simple rule of putting the customer first by giving a personal service that exceeds the customer's expectations and working in partnership in order to develop business for mutual benefit.

Silla has plans to invest ?4 million in expansion plans which would enable the company to increase production capacity to match customers' needs and become a major producer of soft drinks and spring waters. At present the company supplies over 60 million bottles of product per annum mixed between established brands and customers own label products. With the additional production capacity Silla would have the potential to increase this to over 100 million bottles per year if required and if continental shift working over weekends was introduced.

Income Statement for the year ended 30 April

2007 2006
?000 ?000
Turnover 8,411 7,804
Gross Margin 3,365 2,547
Operating Expenses 1,682 2,243
Operating Profit 1,683 304
Interest Payable 140 140
Profit before Tax 1,543 164
Tax 414 47
Profit after tax 1,129 117
Dividends 537 537
Retentions 592 (420)

Balance Sheets as at 30 April

2007 2006
?000 ?000 ?000 ?000
Fixed Assets 5,779 5,370

Current Assets
Stock 935 1,168
Debtors 1,752 2,243
Bank 19 -
2,706 3,411
Amounts due within one year (911) (1,799)
Amounts due after one year
10% Debentures 2010 (1,168) 627 (1,168) 444
6,406 5,814

Financed by:
?0.25 Ordinary Shares 3,855 3,855
Retained Earnings 2,551 1,959
6,406 5,814
At the end of 2006 Silla's shares were quoted at ?2.30 each. After the announcement of the expansion plans they fell quite quickly to finish 2007 at ?1.40 each. The average price/earnings ratio for the soft drinks sector is currently 18.

Further details of the ?4 million plan mentioned above are given below:
? The outsourcing of production to a third world country. This would enable the company to make significant savings in wages costs;
? An aggressive marketing campaign aimed at increasing the company's share of the soft drinks market. The company is aiming to capture a significant share of the highly competitive, but rapidly growing, health and lifestyle drinks market;
? The company is projecting, as a result, increases to its annual net cash flows of ?500,000 in the first year. It is confident that these should grow 15% per year for at least the next four years after that. After this they should remain stable for the foreseeable future;
? The company's cost of capital is 15%.

Silla had hoped to raise the ?4 million required for the expansion by making a 1 for 7 rights issue at ?1.82 per share. The company concedes, however, that the fall in the share price has made this difficult.

a) Assess the financial health and performance of the company by calculating and analysing the following ratios:
? Gross margin
? Interest Cover
? Dividend Yield
? Dividend Cover
? Earnings per share
? Price/Earnings Ratio.

b) Using net present value recommend whether or not Silla should undertake the expansion programme.

c) Assuming that Silla's financial advisors recommend a discount of at least 20% on current share prices to ensure the success of a rights issue; explain why the company chose ?1.82 as their original rights price. Calculate what the terms of the offer would have to be given the current share price of ?1.40. Show the theoretical effect on share prices of a successful rights issue under those terms.

d) Some of the members of Silla's management team believe that a possible explanation of the company's poor share price performance could be ethical. They point out that the share price started to fall almost immediately after the announcement of the planned expansion.

Discuss and explain just what ethical issues might be troubling the financial markets enough to make the share price fall by so much.

e) Critically discuss the procedure, merits and disadvantages of fair valuation of financial and derivative instruments.

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