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CASE SUMMARY:
Challenge:
In February 1969, Walter Bennett, the treasurer of Crown Corporation was faced
with the challenge of raising $30 million in funds to complete the construction of an
aluminum plant and to fulfill working capital requirements. He has three main
funding options for the corporation that will be discussed later in the case.
To meet the demands of growing sales and to retain a competitive edge, Crown had to
obtain $30 million of funds. This was their only option in terms of meeting their own
growth potential. If they did not complete the plant construction and obtain working
capital, the company would not be able to increase its production capacity and would
then lose the increased sales they could reasonably expect over the next several years.
Goals:
To hold to a $0.70 dividend rate
To have a financing plan that will help meet both the short-term and long-term
needs of the company.
Historical background:
Crown's sales are evenly divided between casting and aluminum products.
The completion of the new plant will increase Crown's capacity by about 85
million pounds per year and increase revenues by $3 to $4 million per year.
Crown is constantly threatened with new entrants to the market of fabricated
products. The fact that so many small independent companies entered this part of
the industry caused prices to drop by 20 percent between late 1961 and late 1963.
Demand-supply conditions improved, however, and demand rose by 14 percent
between 1961 and 1966. Prices, however, were still depressed.
Earnings were erratic ranging from a high of $1.13 in 1959 to a low of $0.34 in
1963.
Profits in the industry went from $88 million in 1960 to $230 million in 1966 and
Crown's dividends increased from $0.34 per share in 1960 to $2.07 in 1967.
1
Aluminum imports were increasing and it was estimated that supply from foreign
manufacturers would be twice the production of American producers.
Supply was estimated to exceed demand over the next several years. Analysts
suggested the supply could be as much as 9 percent more than the demand over
the next few years into the 1970s.
Crown's expected sales growth over the next few years was expected to be
between 6 and 8 percent per year.
Funding Options:
There were three major funding options that were available to Mr. Bennett in 1969 to
raise $30 million:
Equity funding through the sale over a million shares of stock
A loan from a consortium of banks at 7.25% percent interest repayable at a rate of
$5 million per year beginning in 1970 and ending in1975
Plan to place $30 million subordinated convertible debenture issue with Northern
Life Insurance Company, a coupon of 6% and annual debt retirement of 42
million from years 6 through 20years.
Each of the options had its advantages and disadvantages. Bennett was more
interested in the debt alternatives but he also saw that equity financing could be
helpful in future years.
2
Question 1: Projected Crown’s income statements and balance sheets for the years
1969-1972.
Cash Flows
Year 1968 1969 1970 1971 1972NWC 68.00 74.78 84.95 87.73 106.50Change in NWC -10.00 6.78 10.17 2.78 -59.00Dep 5.00 5.00 5.00 5.00 5.00Capex -86.00 39.00 32.00 7.00 50.00FCF=ebit+dep-capex-change in nwc -42.50 -10.78 -5.17 29.22 50.00 Debt/ new equity 52.00 30.00 22.00 0.00 30.00Deffered taxes 3.00 3.00 3.00 3.00 3.00interest -3.36 -3.36 -3.36 -3.36 -3.36
dividend -4.00 -4.00 -4.00 -4.00 -4.00
CASH 5.14 14.86 12.47 24.86 75.64
Debt option 1969 1970 1971 1972
Net Sales 246 263 282 301(growth of 6-8%:given) Operating expense 216 231 248 265(88% of sales) Operating Income 30 32 34 36 Other expense (income)* 4.36 6.54 6.54 6.54 EBT 25.64 25.47 27.47 29.47 Tax at 44% 11.28 11.20 12.08 12.96 NI 14.36 14.26 15.38 16.50 Per share data: EPS 1.97 1.96 2.11 2.27 Dividend 0.70 0.70 0.70 0.70
3
Income Statement (Debt financing):
Net Sales:
In case of Debt financing, net sales increased from $230mil to $246 mil . We also can
observe an increasing trend from the year 1969 to 1972.Net Sales are $263 mil, $282
mil and $301 mil in 1970, 1971 and 1972 respectively.
Operating Profit:
Operating profit increased by $1.5 mil from the year 1968 to 1969.There is a gradual
increase in operating profit during 1969-1972.Operating profit is $32 mil, $24 mil &
$36 mil in 1970, 1971 and 1972 respectively.
Earning Before Tax(EBT):
In 1970,EBT slightly increased upto $25.47 mil from $25.64 mil in 1969.EBT is also
gradually increasing in 1969-1972.
Earnings Per Share(EPS):
In 1969, EPS increased to $1.97 from $1.87 in 1968.We can observe a very slight
decrease during 1969-1970.EPS again increased in 1971 upto $2.11 and $2.26 in 1972
4
Historical and Proforma Balance Sheet For debt fin:Year 1965 1966 1967 1968 1969 1970 1971 1972
Cash 3.00 3.00 5.00 4.00 5.00 15.00 12.00 25.00 Marketable securities (7% of sales) 7.00 10.00 23.00 6.00 17.22 18.41 19.74 21.07Accounts Receivable (15% of sales) 20.00 23.00 35.00 42.00 36.90 39.45 42.30 45.15
Inventories (21% of sales) 28.00 38.00 45.00 50.00 51.66 55.23 59.22 63.21
Other (0.004% of sales) 0.00 0.00 1.00 1.00 0.98 1.05 1.13 1.20
Total current asset 58.00 74.00 109.00 103.00 111.76 129.14 134.39 155.6
Investment in aluminium plants 32.00 29.00 34.00 40.00 39.00 32.00 7.00 50.00Other net property, plant and equipment 28.00 31.00 34.00 42.00 72.00 69.00 94.00 37.00
other 3.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00
Total assets 121.00 138.0 181.00 189.00 226.76 234.14 239.39 246.6
Liabililities Accounts Payable (6% of sales) 8.00 10.00 13.00 14.00 14.76 15.78 16.92 18.06Accrued Liabilities (4% of sales) 6.00 7.00 7.00 10.00 9.84 10.52 11.28 12.04
Accrued Taxes (3% of sales) 4.00 8.00 8.00 6.00 7.38 7.89 8.46 9.03
Dividends Payable 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00Current Maturities - long term debt 2.00 2.00 2.00 4.00 4.00 9.00 9.00 9.00
Total Current Liabilities 21.00 28.00 31.00 35.00 36.98 44.19 46.66 49.13
Long Term Debt 30.00 28.00 56.00 52.00 78.00 69.00 60.00 51.00Deferred Federal taxes (1% of sales) 1.00 2.00 3.00 3.00 2.46 2.63 2.82 3.01
Stock holder's equity 69.00 80.00 91.00 99.00 109.00 119.00 130.00143.0
0 Total Liabilities and net worth 121.00 138.0 181.00 189.00 226.44 234.82 239.48 246.1
5
Balance Sheet (Debt financing):
Current Assets:
Cash increased by $1 mil during 1968-1969.There is a sharp increase by $10 mil in
cash during 1969-1970.Again cash decreased upto $12 mil in 1971.In 1972,cash
increased upto $25 mil.In case of Marketable securities, we can observe an increasing
trend during 1969-1972.In 1969,there was a sharp rise in marketable securities.
Accounts receivable decreased moderately from the year 1969 to the year 1969 and
had shown a gradual increasing trend during 1969-1972.Inventories also increased
from $51.66 mil in 1969 to $63.21 mil in 1972.Total current assets including other
current assets are $111.76 mil,$129.14 mil,$134.39 mil,$155.63 mil in
1969,1970,1971 and 1972 respectively.
Long term Assets:
Investment in aluminum plants slightly decreased to $39 mil from $40 mil during
1968-1969 and again decreased to $32 mil in 1970.In 1970, it sharply declined upto
$7 mil but in 1972 it dramatically increased upto $50 mil.Other net properties, plant
and equipment were $72 mil,$69 mil,$94 mil,$37 mil in 1969,1970,1971 & 1972
respectively.
Total Assets:
Total assets were $226.76 mil , $234.14 mil, $239.39 mil & $246.63 mil in 1969,
1970, 1971 & 1972 respectively. So, total assets increased by $19.87 during 1969-
1972
Current Liabilities:
Accounts payable are $14.76 mil, $15.78 mil, $16.92 mil & $18.06 mil in 1969, 1970,
1971 & 1972.Accrued liabilities are $9.84 mil,$10.52 mil,$11.28 mil & $12.04 mil in
1969, 1970, 1971 & 1972.Accrued taxes increased by $1.65 mil during 1969-
1972.Dividends payable remain constant of $1 mil in these four years. Current
6
maturities of long term debt are $ 4 mil in 1969 & $9 mil in 1970-1972. Total current
liabilities are $36.98 mil, $44.19 mil,$ 46.66 mil & $49.13 mil in 1969, 1970, 1971 &
1972 respectively. So, current liabilities increased from $36.98 mil to $49.13 mil
during 1969-1972
Long term debt:
Long term debt are$78 mil, $69 mil,$60 mil & $51 mil in 1969, 1970, 1971 &
1972.So we can see that initially it showed slightly decreasing trend and had
moderately decreased in 1972.
Stockholder’s equity:
Stockholder’s equity increased from $109 mil to $119 mil during 1969-1970 &
increased from $130 mil to $143 mil during 1971-1972.
Total Liabilities & net worth:
Total Liabilities & net worth increased from $226.44 mil to $234.82 mil during 1969-
1970 & increased from $239.48 mil to $246.14 mil during 1971-1972.
7
Equity 1969 1970 1971 1972
Net Sales 246 263 282 301(growth of 6-8%:given) Operating expense 216 231 248 265(88% of sales) 30 32 34 36 Other expense (.33%) 1.00 1.00 1.00 1.00 EBT 29.00 31.00 33.00 35.00 Tax at 44% 12.76 13.64 14.52 15.4 NI 16.24 17.36 18.48 19.60 Per share data: EPS 1.87 2.00 2.13 2.26 Dividend 0.7 0.7 0.7 0.7
Income Statement (Equity Financing ):
Net Sales:
In case of Debt financing, net sales increased from $230mil to $246 million during
1968-1969. We also can observe an increasing trend from the year 1969 to 1972.Net
Sales are $263 mil, $282 mil and $301 mil in 1970, 1971 and 1972 respectively.
Earning Before Tax(EBT):
In 1970, EBT slightly increased up to $31.00 mil from $29.00 mil in 1969.EBT is also
gradually increasing in 1969-1972.
Earnings per Share (EPS):
EPS is also gradually increasing in 1970-1972.It increased from $1.87 mil to $2 mil
in 1970 and then again increased to $2.13 mil in 1971.Finally it reached upto $2.26
8
mil in 1972.
Balance Sheet (Equity Financing):
Current Assets:
9
Historical and Proforma Balance Sheet For equity fin:ASSETS 1965 1966 1967 1968 1969 1970 1971 1972
Cash 3.00 3.00 5.00 4.00 5.00 15.00 12.00 25.00 Marketable securities (7% of sales) 7.00 10.00 23.00 6.00 17.22 18.41 19.74 21.07Accounts Receivable (15% of sales) 20.00 23.00 35.00 42.00 36.90 39.45 42.30 45.15Inventories (21% of sales) 28.00 38.00 45.00 50.00 51.66 55.23 59.22 63.21Other (0.004% of sales) 0.00 0.00 1.00 1.00 0.98 1.05 1.13 1.20
Total current asset 58.00 74.00 109.00 103.00 111.76 129.14 134.89 154.63
Investment in aluminium plants 32.00 29.00 34.00 40.00 39.00 32.00 7.00 50.00Other net property, plant and equipme 28.00 31.00 34.00 42.00 72.00 90.00 93.00 66.40other 3.00 4.00 4.00 4.00 4.00 4.00 4.00 5.00
Total assets 121.00 138.00 181.00 189.00 226.76 256.14 239.89 276.03
Liabililities Accounts Payable (6% of sales) 8.00 10.00 13.00 14.00 14.76 15.78 16.92 18.06Accrued Liabilities (4% of sales) 6.00 7.00 7.00 10.00 9.84 10.52 11.28 12.04Accrued Taxes (3% of sales) 4.00 8.00 8.00 6.00 7.38 7.89 8.46 9.03Dividends Payable 1.00 1.00 1.00 1.00 2.00 2.00 2.00 2.00Current Maturities - long term debt 2.00 2.00 2.00 4.00 4.00 4.00 4.00 4.00Total Current Liabilities 21.00 28.00 31.00 35.00 36.98 44.19 46.66 49.13Long Term Debt 30.00 28.00 56.00 52.00 48.00 44.00 40.00 36.00Deferred Federal taxes (1% of sales) 1.00 2.00 3.00 3.00 2.46 2.63 2.82 3.01Stock holder's equity 69.00 80.00 91.00 99.00 139.00 149.00 169.00 173.00
Total Liabilities and net worth 121.00 138.00 181.00 189.00 226.44 256.82 239.48 276.14
Cash increased by $1 mil during 1968-1969.There is a sharp increase by $10 mil in
cash during 1969-1970.Again cash decreased upto $12 mil in 1971.In 1972,cash
increased upto $25 mil.In case of Marketable securities, we can observe an increasing
trend during 1969-1972.In 1969,there was a sharp rise in marketable securities.
Accounts receivable decreased moderately from the year 1969 to the year 1969 and
had shown a gradual increasing trend during 1969-1972.Inventories also increased
from $51.66 mil in 1969 to $63.21 mil in 1972.Total current assets including other
current assets are $111.76 mil,$129.14 mil,$134.39 mil,$155.63 mil in
1969,1970,1971 and 1972 respectively.
Long term Assets:
Investment in aluminum plants slightly decreased to $39 mil from $40 mil during
1968-1969 and again decreased to $32 mil in 1970.In 1970, it sharply declined upto
$7 mil but in 1972 it dramatically increased upto $50 mil.Other net properties, plant
and equipment were $72 mil,$90 mil,$93 mil,$66.4 mil in 1969,1970,1971 & 1972
respectively.
Total Assets:
Total assets were $226.76 mil , $256.14 mil, $239.89 mil & $276.03 mil in 1969,
1970, 1971 & 1972 respectively. So, total assets increased by $49.27 during 1969-
1972
Current Liabilities:
Accounts payable are $14.76 mil, $15.78 mil, $16.92 mil & $18.06 mil in 1969, 1970,
1971 & 1972.Accrued liabilities are $9.84 mil,$10.52 mil,$11.28 mil & $12.04 mil in
1969, 1970, 1971 & 1972.Accrued taxes increased by $1.65 mil during 1969-
1972.Dividends payable increased by $1 mil during 1968-1969 & remain constant of
$2 mil for the next three years. Current maturities of long term debt remain constant
of $4 mil during 1969-1972. Total current liabilities are $36.98 mil, $44.19 mil,
$46.66 mil & $49.13 mil in 1969, 1970, 1971 & 1972 respectively. So, current
liabilities increased from $36.98 mil to $49.13 mil during 1969-1972
Long term debt:
Long term debt are$48 mil, $44 mil,$40 mil & $36 mil in 1969, 1970, 1971 &
1972.So we can see that initially it showed a decreasing trend during 1969-1972.
10
Stockholder’s equity:
Stockholder’s equity increased from $139 mil to $149 mil during 1969-1970 &
increased from $169 mil to $173 mil during 1971-1972.
Total Liabilities & net worth:
Total Liabilities & net worth increased from $226.44 mil to $256.82 mil during 1969-
1970 & increased from $239.48 mil to $276.14 mil during 1971-1972.
For subordinated debt 1969 1970 1971 1972
Net Sales 246 263 282 301(growth of 6-8%:given) Operating expense 216 231 248 265(88% of sales) 30 32 34 36 Other expense (.33%) 2.80 2.80 2.80 2.80 EBT 27.20 29.20 31.20 33.20 Tax at 44% 11.968 12.848 13.728 14.608 NI 15.23 16.35 17.47 18.59 Per share data: EPS 2.09 2.25 2.40 2.56 Dividend 0.7 0.7 0.7 0.7
Income Statement (subordinated debt financing):
11
Net Sales:
In case of Debt financing, net sales increased from $230mil to $246 mil during 1968-
1969. We also can observe an increasing trend from the year 1969 to 1972.Net Sales
are $263 mil, $282 mil and $301 mil in 1970, 1971 and 1972 respectively.
Earnings Before Tax (EBT):
In 1970, EBT increased up to $29.20 mil from $27.20 mil in 1969. EBT is also
gradually increasing in 1969-1972.
Earnings Per Share (EPS):
In 1969, EPS increased to $2.09 from $1.87 in 1968. We can observe a slight increase
during 1969-1972.
Historical and Proforma Balance Sheet For Subordinate debt:1965 1966 1967 1968 1969 1970 1971 1972
Cash 3.00 3.00 5.00 4.00 5.00 15.00 12.00 25.00 Marketable securities (7% of sales) 7.00 10.00 23.00 6.00 17.22 18.41 19.74 21.07Accounts Receivable (15% of sales) 20.00 23.00 35.00 42.00 36.90 39.45 42.30 45.15Inventories (21% of sales) 28.00 38.00 45.00 50.00 51.66 55.23 59.22 63.21Other (0.004% of sales) 0.00 0.00 1.00 1.00 0.98 1.05 1.13 1.20 Total current asset 58.00 74.00 109.00 103.00 111.76 129.14 134.39 155.63
Investment in aluminium plants 32.00 29.00 34.00 40.00 39.00 32.00 7.00 50.00Other net property, plant and equipment 28.00 31.00 34.00 42.00 72.00 68.00 98.00 46.00other 3.00 4.00 4.00 4.00 4.00 5.00 5.00 5.00Total assets 121.00 138.00 181.00 189.00 226.76 234.14 244.39 256.63
Liabililities Accounts Payable (6% of sales) 8.00 10.00 13.00 14.00 14.76 15.78 16.92 18.06Accrued Liabilities (4% of sales) 6.00 7.00 7.00 10.00 9.84 10.52 11.28 12.04Accrued Taxes (3% of sales) 4.00 8.00 8.00 6.00 7.38 7.89 8.46 9.03Dividends Payable 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00Current Maturities - long term debt 2.00 2.00 2.00 4.00 4.00 4.00 4.00 4.00Total Current Liabilities 21.00 28.00 31.00 35.00 36.98 39.19 41.66 44.13
Long Term Debt 30.00 28.00 56.00 52.00 48.00 44.00 40.00 36.00Subordinate debt 30.00 30.00 30.00 30.00Deferred Federal taxes (1% of sales) 1.00 2.00 3.00 3.00 2.46 2.63 2.82 3.01Stock holder's equity 69.00 80.00 91.00 99.00 109.00 119.00 130.00 143.00 Total Liabilities and net worth 121.00 138.00 181.00 189.00 226.44 234.82 244.48 256.14
12
Balance Sheet (Subordinate Debt financing):
Current Assets:
Cash increased by $1 mil during 1968-1969.There is a sharp increase by $10 mil in
cash during 1969-1970.Again cash decreased upto $12 mil in 1971.In 1972,cash
increased upto $25 mil.In case of Marketable securities, we can observe an increasing
trend during 1969-1972.In 1969,there was a sharp rise in marketable securities.
Accounts receivable decreased moderately from the year 1969 to the year 1969 and
had shown a gradual increasing trend during 1969-1972.Inventories also increased
from $51.66 mil in 1969 to $63.21 mil in 1972.Total current assets including other
current assets are $111.76 mil,$129.14 mil,$134.39 mil,$155.63 mil in
1969,1970,1971 and 1972 respectively.
Long term Assets:
Investment in aluminum plants slightly decreased to $39 mil from $40 mil during
1968-1969 and again decreased to $32 mil in 1970.In 1970, it sharply declined upto
$7 mil but in 1972 it dramatically increased upto $50 mil.Other net properties, plant
and equipment were $72 mil,$68 mil,$98 mil,$46 mil in 1969,1970,1971 & 1972
respectively.
Total Assets:
Total assets were $226.76 mil , $234.14 mil, $244.39 mil & $256.63 mil in 1969,
1970, 1971 & 1972 respectively. So, total assets increased by $29.87 during 1969-
1972
Current Liabilities:
Accounts payable are $14.76 mil, $15.78 mil, $16.92 mil & $18.06 mil in 1969, 1970,
1971 & 1972.Accrued liabilities are $9.84 mil,$10.52 mil,$11.28 mil & $12.04 mil in
1969, 1970, 1971 & 1972.Accrued taxes increased by $1.65 mil during 1969-
1972.Dividends payable remain constant of $1 mil in these four years. Current
maturities of long term debt remain constant of $ 4 mil in these four years. Total
current liabilities are $36.98 mil, $39.19 mil,$ 41.66 mil & $44.13 mil in 1969, 1970,
1971 & 1972 respectively. So, current liabilities increased from $36.98 mil to $44.13
mil during 1969-1972
13
Long term debt:
Long term debts are$48 mil, $44 mil,$40 mil & $36 mil in 1969, 1970, 1971 &
1972.So we can see that it showed decreasing trend during 1969-1972.
Subordinate Debt:
There are constant subordinate debts of $30 mil in these four years.
Stockholder’s equity:
Stockholder’s equity increased from $109 mil to $119 mil during 1969-1970 &
increased from $130 mil to $143 mil during 1971-1972.
Total Liabilities & net worth:
Total Liabilities & net worth increased from $226.44 mil to $234.82 mil during 1969-
1970 & increased from $244.48 mil to $256.14 mil during 1971-1972.
Question 2:
Recommend and defend the financing decisions that Crown’s management
should make in 1969.
Answer 2:
Crown already had a $56 million debt issue with several insurance companies, which
was contracted in 1967. $26 million of that balance was for refinancing and $30
million was new debt. A $30 million loan in 1969 would further increase their debt to
over $80 million.
Although there are of advantages associated with the debt financing options like: the
interest paid is tax deductible; there is a definite repayment schedule that allows the
company to plan; debt repayment has priority over equity contributions; cost of debt
is less than cost of equity. The major disadvantage here would be that the debt-to-
equity ratio for 1969 will rise to 72% from about 50% in 1969. Due to this high debt
to equity ratio, the regulatory agencies scrutinize the company's reports even more
intensely. Also as debt will increase the cost of equity will further increase.
14
Equity financing, on the other hand, means more stockholders but there is also a
potential for greater growth. Secondly the likelihood of a higher credit rating because
the company is not overly indebted; might very likely raise more money than the
needed $30 million. Also dividend paid is not a mandatory obligation like interest
payment on debt. The disadvantages of equity financing include the fact that
dividends will vary according to the company's profit margins; dividends are not
deductible as is interest paid on a loan, dividends are paid only after all the other
obligations are met and thus, there is no way to guarantee any specific dividend level
for investors.
If the company takes the loan from the banks or it issues bonds through the insurance
company, it will still raise its debt ratio significantly. Total long-term debt would be a
remarkable $82 million. The proportion of debt would rise from about 30+ percent to
between 40 and 50 percent of the value of the company. That seems like a bad move.
Also comparing the three financing options available to Crown based on
proforma income statement and balance sheet for 1969 we have:
(all figs in million $)
DEBT EQUITY SUB DEBT
NI 14.36 16.24 15.23
EPS 1.97 1.87 2.09
ROA 6.35 7.19 6.74
(NI/TA)
ROE 13.17 11.94 13.97
(NI/Comm. Equi)
TIE 5.42 8.93 5.81
(EBIT/Int)
BEP 13.27 13.27 13.27
(EBIT/TA)
D/E 72% 34% 72%
Based on the above analysis we observe that:
15
Net income and Return on Assets is highest for equity financing in 1969.
The Earnings Per Share is higher for both the debt financing options than the
equity option because as a firm increases its leverage the risk borne by
stockholders increases, so they require a higher return on equity.
But the EPS of $1.87 under equity financing is sufficient to maintain the required
dividend payout rate of 70 cents per share.
The Times interest earned ratio is also the highest for equity financing.
Equity financing thus offers a better option at this point in time. Crown is likely to
obtain more than the $30 million needed and such financing will keep the debt ratio
down while providing greater growth opportunities. Given the situation at the time,
including the forecasts for increased revenue in the early 1970s, equity financing
would also lead to Bennett's goal of $0.70 cents dividend per share.
Q3. Indicate the plan of action that should be set up to meet the company’s
anticipated finance requirements over the next 3—5 years, and show why your
recommended plan is better suited to the company’s needs than viable alternative
plans.
Ans:3
According to the text, Crown will need $30 million in 1969, $22 million in 1970, and
$30 million in 1972. In 1971 Crown has no external financing; the corporation will be
able to finance the capital expenditures on their own. The pattern shown is of heavy
financing in the first two years then a break year, then another heavy year in '72. The
large projected capital expenditures in 1969 and 1970 are a result of the Eastalco
project. In 1972 the heavy capital expenditures are for the expansion of the Eastalco
project.
There was an increase in aluminum prices.
The case indicates that there were shortages of aluminum.
A large common stock increase could dilute dividends and stock price (holding
the dividend rate at $0.70 was a major goal of Mr. Bennett).
For a better analysis, we have done ratio analysis of the forecasted years. We have
tried to compare the result of ratios taking three financial alternatives discussed in the
16
case.
Debt Ratios Company using debt- financing : 1969 1970 1971 1972 Average Debt/ Total Asset 0.52 0.49 0.46 0.42 47%Debt /Total Equity 1.08 0.97 0.84 0.72 81%Time Interest Earned Ratio(EBIT/ Interest Charges ) 5.42 5.78 6.14 6.50 6.14X Company using Equity-Financing : 1969 1970 1971 1972 Average Debt/ Total Asset 0.39 0.35 0.37 0.32 36%Debt /Total Equity 0.63 0.61 0.53 0.51 27%Time Interest Earned Ratio(EBIT/ Interest Charges ) 8.93 9.52 10.12 10.71 9.82X Company using Subordinate- Debt : 1969 1970 1971 1972 Average Debt/ Total Asset 0.52 0.49 0.47 0.44 48%Debt /Total Equity 1.08 0.97 0.88 0.79 58%Time Interest Earned Ratio(EBIT/ Interest Charges ) 5.81 6.20 6.59 6.98 6.40X
Debt/ Total Asset Ratio: Debt/ Total Asset are percentage of assets financed by
long-term and short-term debt. From the above table, we can see that Debt/ Total
Asset is highest (48%) when the company used Subordinate Debt. The second option
where company has a low debt ratio (36%) if it follow equity financing to raise fund.
Creditors prefer low debt ratios because lower the ratio, the greater the cushion
against creditor’s losses in the event of liquidation. The stockholders, in the other
hand can get benefit from leverage because it magnifies earnings, thereby increasing
the return to stockholders. One point we should keep in mind that too much debt can
leads the company to financial difficulty, which eventually can cause bankruptcy.
Long Term Debt/ Total Equity: This ratio states that proportion of financing that is
debt-related. Crown Company had already issued debt in its past years for its
operation and expansion of plants to cover capital needs. It will have 27% debt –
equity ratio if company raises new equity. From the case, industry average is given
43%. For Crown, both cases long-term Debt/ Equity ratios are higher if the company
finance debt or subordinate debt. Therefore Crown can face bankruptcy.
17
Time Interest Earned: This ratio shows us the ability of the firm to meet
interest obligations. If the company use equity finance, company‘ll have higher Time
Interest Earned Ratio. Whereas, using debt/ subordinate financing tools result into low
ratios (6.14-6.40%). According to the case, industry average is 6.48%. Therefore
Crown can cover its interest charges by a margin of safety. But based on the debt ratio
and long term debt equity ratios Crown may face difficulties if its attempt to borrow
funds.
Profitability Ratios
Company using debt- financing : 1969 1970 1971 1972 Average
ROA 6.33 6.09 6.42 6.69 6.38%
ROE 13.17 11.98 11.83 11.54 12.13%
Company using Equity-Financing : 1969 1970 1971 1972 Average
ROA 7.16 6.78 7.70 7.10 7.19%
ROE 11.68 11.65 9.61 11.33 11.07%Company using Subordinate- Debt : 1969 1970 1971 1972 Average
ROA 6.72 6.98 7.15 7.24 7.02%ROE 13.97 13.74 13.44 13.00 13.54%
Return on Assets: ROA tell us asset utilization in producing returns. From the
above table, we can see that ROA of Equity Finance provides us 7.19%. Crown will
have low returns (6.38% and 7.02%) using debt financing and subordinate financing.
It is because Crown had already taken debt in past years. Moreover, issuing more debt
will cause Crown higher use of debt.
Return on Equity: Return on Equity shows us effectiveness of equity investment
in producing returns. The rate of return of the stock holder decreases when Crown
raised fund by issuing more equity. ROE is highest (13.54%) when company uses
subordinate debt.
Other Ratios
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Company using debt- financing : 1969 1970 1971 1972 Average Book Value Per Share 14.99 16.36 17.87 19.66 17.22
Earning Per Share 1.97 1.96 2.11 2.27 2.08
Company using Equity-Financing : 1969 1970 1971 1972 Average Book Value Per Share 19 20 23 24 21.66Earning Per Share 1.87 2.00 2.13 2.26 2.07
Company using Subordinate- Debt : 1969 1970 1971 1972 Average Book Value Per Share 14.99 16.36 17.87 19.66 17.22Earning Per Share 2.09 2.25 2.40 2.56 2.33
Book Value per Share: When Company using Equity – Financing Book value per
share is highest than company using debt financing and subordinate debt .
Earnings Per Share: The price earnings ratios shows how much investors are willing
to pay per dollar of reported profits. Earnings Per share are highest when the company
used subordinate- Debt. From the case, we have seen that Crown has low earning per
share compared to other companies in the same industry. This gives us indication that
other companies have high growth prospect than Crown. Therefore Crown could be a
riskier firm compare to other companies in the industry.
Crown is in an extremely volatile and sensitive industry. The degree of business risk
attributable to this industry is relatively high. As Crown expands, they will leave
themselves more vulnerable to risk. Although, an equity issue can dilute dividends to
below Mr. Bennett's $0.70 dividend rate. This in turn could cause stock price to drop
to levels in the low 20's. Either of the financing alternatives via debt could leave
Crown unable to make large debt payments in the event that any of the listed
outcomes (above) become reality. In the event that Crown is unable to meet debt
payments, they could sell off some of their operations. Another possible alternative is
to issue more common stock. This common stock issue could cause stock prices to
drop and Mr. Bennett could possibly have to sacrifice his goal of maintaining the
$0.70 dividend rate.
Overall, looking at the ratio analysis result, we would suggest Crown to go for equity
financing.
There were some limitations in the cases such as follows:
Projected sales increases of 6-8% could be overestimated.
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Aluminum consumption could go down.
The industry rate of expansion (14%) could be too much for the increase in the
rate of demand (9%).
The term loan offered may be too difficult to pay even in the event of normal
earnings in years '70 and '72 due to large capital expenditures.
Recession
Competition from the large steel industry may affect the much smaller aluminum
industry's sales. These are some of the things that could go wrong for the Crown
corporation.
The events that would affect Crown the most would be overestimated sales
estimates or inability to make debt payments caused by any of the following; drop
in consumption, too much industry expansion, recession, mining operations are
unable to produce enough to meet production needs, etc.. Other than these
problems that could occur Crown's new projects could fail to meet expectations.
Recommendation
To prevent against increases in aluminum prices due to shortage, Crown could
increase it's mining holdings. Currently Crown estimates producing a surplus of
aluminum in years after 1970. If these estimates hold true, then Crown will not have
to worry about price increases for a few years. However, if Crown's fabricating plant
continues to increase consumption at this rate a future problem could arise if Crown
would have to purchase aluminum again. Crown currently holds a lot of industry risk
due to aluminum operations. Crown could explore new markets to diversify risk.
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