DEBT POLICY

Continen
tal
 Carriers,
Inc.

I. Introduction

Continental Carriers Inc is a trucking company which focuses in carrying general

commodities. From the start of its operation in 1952, the company manages within the
district of the Pacific Coast and from Chicago to various places in Texas. They attained
few short term loans resulting from a low debt policy and evading long term debt. The
company obtained its profitability and internal growth from the time that Mr. John Evans
was appointed as President of the company. He focused on rigorous marketing and
high-tech operations. Because of this, the company became known in the trucking
industry as a widely profitable key performer because of its unremitting revenues and
declining operating costs.

Because of the president’s eagerness to preserve and develop the company’s

profitability, he supported the acquisition of Midland Freight, a common carrier serving
Michigan and Indiana from Chicago expecting that it would expand CCI’s route system
and appeared well suited for the type of marketing and cost-reduction programs that
had cultivated CCI’s growth. He believed that in order to carry out this goal and
objective, there should be an external financing of $50 million.

This study provides a comprehensive insight to the company. The hallmark of the
report is the detailed strategic analysis and the right decision that the company should
put into action in order to expand its revenue and decrease its operating costs through
external financing. It also aims to build analysis, solutions and recommendation on how
it will attain its goals and objectives.
II. Executive Summary

III. Highlights

IV. Company History

V. Point of View

JOHN EVANS

President of Continental Carrier, Inc.

VI. Time Context

 1982-1997

VII. Statement of the Problem

 Which among the three options should CCI choose in order to attain its
goal?
 A) selling $50 million in bonds at a 10% interest rate to a California Insurance
Company and with maturity of 15 years;

B) issuing 3 million in common stocks at $17.75 per share with a dividend rate
of $1.50 per share;

C) issuing 500 000 preference shares at a par of $100 per share and with a
dividend rate of $10.50 per share

 What are the advantages and disadvantages of the several alternative

methods of financing CCI’s acquisition of Midland Freight, Inc.?

VIII. Objectives

 To determine the best financing source that will maximize the wealth of
the company’s owners.

 To study the advantages and disadvantages of the acquisition of Midland

Freight Inc.

IX. Areas of Consideration

INTERNAL / EXTERNAL ANALYSIS

Strengths:

 A successful performer financially – market confidence in its capability

for continued revenue growth
  Acquisitive/growth oriented

 Low operating cost

 The company currently does not pay any interest expense because it
does not use any long-term debt.

 Rated as an attractive by above average return performance

Weaknesses

 policy of avoiding long term debt

X. Alternative Strategies

Presented below are the options available for the company:

• BOND/DEBT FINANCING

Advantages:
 1. Less amount of taxes

2. Has a positive DFL which means that a change in the level of EBIT will
positively affect the EPS

3. High debt ratio resulting from the firm’s degree of indebtedness and
high financial leverage.
4. Least cost of financing.
5. Higher EPS than stock.
6. Higher potential return.
7. Using debt to raise funds will be viewed positively by existing
shareholders, as they will fully capture the total increased value of their
stocks.
8. No payment of dividends

Disadvantages:

1. Greater level of financial risk.

2. Payment of interest.

• PREFFERED STOCK FINANCING

Advantages:

1. Outflows only consist of dividend payments.

2. No principal has to be repaid in the future.

3. No payment of interest.
 Disadvantages:

1. High cost of issuance

2. The option for issuing preferred stock will bring about no additional benefit
to the company as the market value of the firm will remain the same
whether additional common stock or preferred stock are issued.

3. Higher amount of taxes.

• COMMON STOCK FINANCING

Advantages:

1. No principal has to be repaid in the future.

2. No payment of interest

Disadvantages:

1. Uncertainty of the offering price for new common stock provide reasons
for raising the required funds through debt or stock price has been very
variable

2. High cost of issuance

3. Higher amount of taxes.

In this case, the company is extremely facing a problem on choosing which

of the options given will be the most beneficial. Here are some of the steps that
the company should consider in order to end up to its desired goals and
objectives.

1. Through getting the income and dividend data for 1988, before the effects of
the acquisition can be reflected, the current operating and financial position of
the Continental Carriers, Inc. must first be evaluated.

2. Consider the effects (positive or negative) of the acquisition on earnings

before interest and taxes, interest expense, tax expense, dividends and key
financial indicators such as the degree of financial leverage, the debt ratio,
earnings per share, and the resulting effective interest rate under each of the
alternatives. This will help the company to overview which alternative will
contribute the most remuneration with the assessment and comparison to the
current situation and to other alternatives.

3. It will be advisable for the company to graphically

4. For each financing plan, it would be functional for the company to graphically
characterize the correlation between the EPS and EBIT.

5. All cash inflows and outflows for the 15 years should be verified with each
alternative form of financing – this will result to exposure to the achievability of
pursuing any one strategy, showing the company’s expected revenues and
costs. (Only disparity costs and revenues tied to each approach should be
used in the study).

6. All qualitative factors should be taken into consideration which has greater
effects in the decision such as company policy and market performance.

Maximization of wealth of existing stockholders, utilization of future earnings and

diminution of risk should be the basis on the company’s preference of financing
 XI. Recommendation

With regard to the evaluation and analysis that we have made, we offer to carry out
the acquisition of long term debt through selling of $50 million worth of bonds to a
California Insurance Company. The best advantage of this option is its lower cost of
financing as compared to the issuance of stock which is the main goal of the Continental
Carriers, Inc. Another thing is, even though the use of bonds will not increase after-tax
earnings, it is still preferable because the bond issue results in interest expenses which
are tax-deductible. There is also a sinking fund which through this, the company will
have more than enough left to pay its common stock shareholder resulting to the
uninterrupted betterment of the market perception of the company’s stock.

And also, through this option, Continental Carriers, Inc can grab the opportunity of
having a high EBIT which is justified by a high Degree of Financial Leverage.
 XII. Plan of Action

Continental Carriers, Inc can achieve its goals and objectives if it will choose the
most effective and advantageous option. The decision of the president of the acquisition
of additional business activities or companies at the same level of the value chain
(which also have strong and firm financial status) is helpful since it will lessen the
pressure of severe competition.

In order to

To issue $50 million in bonds, CCI must first approach a California insurance company to set the
contract. In this indenture, terms of payments must be defined, including the 10% interest rate
applied on these bonds with a 15-year maturity, and the requirement of an annual sinking fund of
$2.5 million.

After the bonds have been issued, the funds acquired will be used for CCI’s acquisition of
Midland freight, Inc. The terms of the merger must be settled after the acquisition. The
expansion of the route system and implementation of marketing and cost reduction programs
must also be decided upon.

Throughout the duration of the bond financing plan, CCI must strictly adhere to the terms of
payments of the bond issue. It must meet its interest payments, and comply with the annual
sinking fund of $2.5 million and the $12.5 million payment at maturity.

The existing shareholders of CCI must be satisfied through the declaration and payment of
annual dividends at $1.50 per share from the company’s retained earnings.

Finally, CCI must ensure that all operational agreements with Midland Freight are closely
monitored to sustain company growth and to maximize owners’ wealth.