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Analysis of recessionary cash flows

Company A is undertaking a thorough cash flow analysis. It has been proposed by management that the firm expand by raising $6million in long term debt markets. All of this would be immediately invested in new fixed assets. The proposed bond issue would carry a 10 percent interest rate and have a maturity period of 20 years. The bond issue would have the sinking fund provision that 0ne-twentieth of the principal would be retired annually. Next year is expected to be a poor one for company A. The firm believes that the upcoming year would serve as the model for the worst possible operating conditions that the firm can be expected to encounter. Next year, sales collections are forecast to be $3.5 million. Miscellaneous cash receipts will total $200,000. Wages and salaries will amount to $1.2 million. Payment for raw material used in production process will be $1.5 million. In addition, the firm will pay $500,000 in nondiscretionary expenditures including taxes. The firm faces 50 percent tax rate.

Question 1: Company A currently has no debt, pr preferred stock outstanding. What will be the total fixed financial charges that the firm must fix next year?

Question 2: What is the expected cash balance at the end of the recessionary period (next year), assuming debt is issued?

Question 3: Based on this information, should company A issue proposed bonds?

What I need help with is the formula and run down of the process to figure out this problem, the explicit answer is not necessary.

Solution Preview

1. Since there is no debt or preferred stock, the fixed financial charges would be from the new bond issue. The financial charges will be the interest and the sinking fund. The interest amount would be 6,000,000 X 10%=600,000 for the first year. The sinking fund is 6,000,000/20=300,000. The ...

Solution Summary

The solution explains how to evaluate an issue of bonds under recessionary conditions