Financial Decision Case

Presentation By:
Haseeb Anwar, Moin Illahi, Ch. Haider,
Ahsan Mukhtar, M.Wasif and Hashim.
Introduction of the case
The companies offering services to the computer
technology industry are growing rapidly.
Participating in this growth, Northeast Servotech
Corporation has expanded rapidly in recent years.
The company has been able to generate profits
without obtaining external financing.
This fact can be seen in the current balance sheet
of the company.
Balance Sheet
Liabilities $ $
Current Liabilities 500,000
Stockholders Equity
Common Stock $10
par value, 100,000
shares issued and
outstanding 1000,000
Paid in capital 1,800,000
Retained Earnings 1,700,000
Total Stockholders
Equity 4,500,000
Total Liabilities and
Stockholders Equity 5,000,000
Problem
The company is now looking at the opportunity
of doubling the size by purchasing the operations
of the rival company for 4000,000
If the purchase go through Northeast will become
the top company in its specialized industry.
The main problem is how to finance the purchase
after much study and discussion with bankers and
underwriters management comes up with 3
alternatives
Alternatives
Alternative A: The company could issue 4000,000
of long term debt. Given the companys financial
rating and the current market rates, it is believed
that the company will have to pay an interest rate
of 17% on the debt.
Alternative B: The company could issue 40,000
shares of 12%, $100 par value preferred stock.
Alternative C: The company could issue 100,000
additional shares of $10 par value common stock.
According to the management:
Long term debt is tax deductible and the income
tax rate is 40%
The board has had a policy of regular increases in
dividends of $0.20 per share

Balance Sheet for Alternative A
Liabilities $ $
Current Liabilities 500,000
Long Term Liabilities 4,000,000
Stockholders Equity
Common Stock $10
par value, 100,000
shares issued and
outstanding 1000,000
Paid in capital 1,800,000
Retained Earnings 1,700,000
Total Stockholders
Equity 4,500,000
Total Liabilities and
Stockholders Equity 9,000,000
*Debt to Equity Ratio: 4,500,000 / 4,500,000 = 1*


Balance Sheet for Alternative B
Liabilities $ $
Current Liabilities 500,000
Stockholders Equity
Preferred Stock $100
par value 40,000
shares of 12% 4,000,000
Common Stock 1000,000
Paid in capital 1,800,000
Retained Earnings 1,700,000
Total Stockholders
Equity 8,500,000
Total Liabilities and
Stockholders Equity 9,000,000

*Debt to Equity Ratio: 500,000 / 8,500,000 = 0.06*

Balance Sheet for Alternative C
Liabilities $ $
Current Liabilities 500,000
Stockholders Equity
Common Stock $10
Par value, 200,000
Shares issued and
outstanding 2000,000
Paid in capital (1,800,000+
3,000,000) 4,800,000
Retained Earnings 1,700,000
Total Stockholders
Equity 8,500,000
Total Liabilities and
Stockholders Equity 9,000,000

*Debt to Equity Ratio: 500,000 / 8,500,000 = 0.06*

Computations and Comparisons
This section will compute and compare the
cash needed to pay the interest or dividend
for each kind of financing net of income taxes
in the first year and how may this requirement
will change in future years.
Alternative-A Alternative-B Alternative-C
Total Cash Required Interest:
4000,000x17/100
=$680,000
Income Tax:
680,000x40/100
=$272,000
Total = $408,000
Dividends:
4000,000x12/100
=$480,000





Dividends:
100,000x$1
=$100,000

Future Changes In
Cash Requirements
This cash
requirement will
remain fixed for the
future years
This cash
requirement will
remain fixed for the
future years.

The cash
requirement will
keep on increasing
by $20,000 each
year as the board of
directors have a
policy of regularly
increasing dividend
by $0.20 per share
each year.

Alternative A
If company issues long term debt of 4million than

Merits
It will not have to pay
dividends for infinite years
Save its cash out flow once
it pay off its long term debt
No effect on the ownership
of the company

De-merits
Debt to equity ratio will
increase after issuance of
long-term debt
Moreover the cost for
taking debt is high which is
around 17%

Alternative B
If company issues preferred stock of $100 par than

Merits
Can get money form a mix of
investors
Ownership of the company
will remain intact
Yearly cash requirement to pay
dividend is less than the
requirement for long term
debt
If stocks are callable than they
can be called back anytime
and future cash outflows can
be saved

De-merits
Company have to pay
dividends every year
weathers its in profits or
losses
Dividends/share is higher
than of common shares
Alternative C
If company issues 100,000 shares of common stock of
$10par value @ 40 each

Merits
It will require less cash than
of other two options
And at the same time it will
give company cushion not
to pay dividends at all if it
faces problem with its cash
flows
Company can also buy back
these shares in future

De-merits
If the company follow its
policy to increase CS
dividends by $.20/share
than company needs to
keep on raising its cash
requirements by $20,000
each year
Existing share prices could
fall due to increase in
supply of shares
Conclusion
Company could issue common stock as it gives
a flexibility of buying back and not to pay any
dividends if in future company faces any
problems with its cash flows and cost of
raising fund by issuing of common stock is also
less as compared to the