1. What is the immediate problem facing CEO Peterson?

How did Pacific Grove Spice

Company end up with this problem? Can Pacific Grove Spice Company quickly work its
way out of this problem? How does this problem constrain Pacific Grove Spice Company’s
operations?
The company is profitable, and all of its net income was re-invested in the firm, but the retained
earnings were not sufficient to fund the growth in assets necessary to support ever-increasing sales.
Therefore, was the remainder of pacific growth financed through short-term notes payable backed
by the company’s accounts receivable, and long-term debt supported by the firm’s other assets and
earnings power.

Unfortunately, the bank was not as comfortable with the total amount of interest-bearing debt on
Pacific’s balance sheet. The bank was because of the financial crisis been under increasing oversight
and pressure from regulators to limit exposure to potential loan losses. The bank recently told
Peterson that it wanted to see an action plan to reduce interest-bearing debt to less than 55% of total
assets and the equity multiplier to less than 2.7 times by June 30, 2012. In addition, bank notes must
not be more than 81% of accounts receivable. If this requirement was not met, the bank would
refuse to extend any additional credit to Pacific forcing the company to find new sources of funding
at a time credit was difficult to obtain.

Pacific Is not able to quickly work its way out of the problem because key metric is not met by June
2012. In addition, Pacific does not have sufficient fund to growth in assets to support ever-
increasing sales. Therefore they need extra funding and additionally it can limit the opportunity to
follow other growth opportunities.
 2. How attractive is the opportunity to produce and sponsor the new television program? Is
Pacific Grove Spice Company in a position to take advantage of this opportunity?
By sponsoring a television program, the company’s sales, profits and operating cash flow would be
potentially increased. As we can see from exhibit 3, this project has tremendous IRR even if the sale
is only 75% of expectation. See picture below, but more information available in exhibit 33.

On the other hand, this project has some drawbacks. Firstly, the company has no expertise in the
show industry and cannot guarantee the projected performance will be correct. Furthermore, this
investment requires substantial upfront capital of $1,440,000 as well as other future expenses.
Given the company’s current financial situation, it is in tight budget. The cash flow from this project
in first year would not be sufficient to cover the cost and better Pacific’s current debt level to
achieve bank’s requirement in 2012.
Income statement:

Balance sheet:
Ratio of banks interest:

3. Should Pacific Grove Spice Company sell new common shares to the external investment
group? What are the strengths and weaknesses of this opportunity?
Another option for Pacific is to issue 400,000 common shares to a particular investment group with
the net proceeds per share of $27.50 due to the cost and discount which the stock is being sold at.
This action would reduce the company’s level of debt while generate sufficient fund to finance its
growth of sales. From my calculation, it will make it possible for Pacific to reach the requirement in
2012 with a debt level of 52.38% and a 2.5 equity multiplier due to cash injection from the share
issuing. Additionally, I have assumed that they have not used their new cash to pay down the debt,
but that would also be a possible solution for them, and it is also possible for them to only use part
of the cash to pay down debt and find the optimal combination for them.
In spite of all the benefits, this option still has several negative impacts on the firm. The first one is
the dilution of ownership, the percentage holding of the investment would be higher than the
holding of the founders and Peterson which gives them right to take part in board voting as well as
management decision making.

Nevertheless, it would also lead to a decrease in EPS. In addition, when a company further issue
shares, it would send false negative signals to outsiders that the company is not doing well and lose
investors’ confidence and eventually lead to further fall in stock price and lowering value of
existing shares.

4. Is the acquisition of High Country Seasonings a good investment opportunity? What are the
free cash flows, risk adjusted cost of capital, and value? Is this a positive net present value
decision for Pacific Grove Spice Company?
The last option is to expand the business through the acquisition of a small successful company
High country Seasonings in the form of common shares with a purchase price of 13.2 meaning that
404,908 shares will be issued and transferred at a price of $32.60 per shares. Apart from the fact
that it has the same dilution issue as option 2, it would be a better option as it put company in the
position of increasing its profitability in the future. The figure exhibit 4 and exhibit 5 reveals that
High country Seasonings was not only having an increasing sale but also having no ling-term debt
that can worsen Pacific situation. Additionally, we further will investigate the option of using the
discounted cash flow method to ensure that the company is not overpriced. AS the firm value is
26,11 the firm is not overpriced hence, this acquisition can be a good choice for Pacific. However, it
is necessary to address the dilution issue.
First, we have the income statement
And balance sheet
Which makes it possible to find the free cash flow:

5. Is the acquisition of High Country Seasonings for stock a good financing decision? Will the
acquisition solve Pacific Grove Spice Company’s financial problems and bring the company
into compliance with the bank’s requirements without investing in the new television
program? Is the company still in compliance if Pacific Grove Spice Company decides to
produce and sponsor the television program? (As I have not done any calculation on the
income statement)
For Pacific view can it be seen as a good financing decision as they can use equity to expand the
company and growth more in the future. In addition, normally people will be against dilution of
their ownership, because it can cause problems in the future, but these seem like a better solution
because at the same time they are growing their firm.
From my calculation, it will make it possible for Pacific to reach the requirement in 2012 with a
debt level of 50.35% and a 2.44 equity multiplier due to the increased cash flow.

Next, we will look into if the company still compliance is if Pacific Grove Spice Company decides
to produce and sponsor the television program.

From my calculation, it will make it possible for Pacific to reach the requirement in 2012 with a
debt level of 50.22% and a 2.45 equity multiplier due to the increased cash flow.
 6. How are the opportunities presented in the case interrelated? What alternatives produce the
maximum benefit to Pacific Grove Spice Company’s shareholders?
In the short term, the company can exercise option 3, as it brings the most benefit for the company
in terms of profit. Or the company can combine option 1 and 2 by funding the TV program using
the cash injection from share issue to finance option 1 and use the cash to pay down debt. As
mentioned above, this is totally possible since after retiring some long-term debt to reach the
requirements, the company would still have extra cash to fund any project. It depends on the firm
situation to allocate how much cash for investment and how much cash to retire debt, which need to
be further analysed. The company can also propose convertible debt to swap into equity to reduce
the level of debt in the company. Another point is that the firm can adjust its term of sale so that its
account receivable can pay faster, and its payable term can be longer. This in turn reduce working
capital needs as account payable can be seen as a form debt. In the long term, the company can buy
back its share when it passed its growth point and has stable revenue. This can boost company share
price.