George Hedderwick finished his customary peanut butter and jelly sandwich, washed it down with a root beer, and turned back to his computer. His morning had been spent developing a financial planning model for Executive Fruit (see Figure 18-2). Now he needed to run out the projections to 2007. In particular, he wanted to check what would happen if the firm continued to expand at 10 percent and relied on new issues of debt to make up any required external financing. Would the standard measures of leverage, such as the debt ratio and the interest cover start to spin out of control? Executive Fruit's bank had stipulated that the company's debt ratio should not exceed 60 percent, and George wanted to see whether there was any risk that this condition would be breached. It might be OK if interest rates stayed at their current level, but it looked as if the Fed could raise rates in the near future. George decided that he would also develop some projections assuming that the interest rate increased from 10 percent to 15 percent.
Although the CEO appeared reluctant to raise new equity, George thought he would take the opportunity to explore other financial strategies. In particular, he was interested to see how things might look if Executive Fruit kept to a constant 40 percent debt ratio. The return on equity might not look so good in this case, but it would certainly keep the company's bankers happy.
George wiped the last piece of jelly from the keyboard and settled down to work.
A. Project future years using the growth rate assumptions in the Mini-case
B. Determine what type and amount of financing may be required, taking into account the impact on leverage ratios© BrainMass Inc. brainmass.com June 3, 2020, 7:58 pm ad1c9bdddf
This solution explains how to determine the standard measures of leverage, like debt ratio and the interest cover.