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Case Study on Crown Corporation PREPARED FOR Dr. Shaikh A. Hamid FIN 680.1 PREPARED BY Abdullah Resalat Rahman 0930477060 Md. Towhidul Hoq 0930393060 Md. Sabbir Alam 0930391060 Md. Nafiz Enam 0930404060 Debabrata Bhowmik 1020071090

Crown Corporation Case Solution - HBS 273-086

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Page 1: Crown Corporation Case Solution - HBS 273-086

Case Study on

Crown Corporation

PREPARED FOR

Dr. Shaikh A. Hamid

FIN 680.1

PREPARED BY

Abdullah Resalat Rahman 0930477060

Md. Towhidul Hoq 0930393060

Md. Sabbir Alam 0930391060

Md. Nafiz Enam 0930404060

Debabrata Bhowmik 1020071090

Page 2: Crown Corporation Case Solution - HBS 273-086

Company Background

Crown Corporation started as mining company, but a series of acquisitions and divestitures

during the 1960s had totally transformed Crown Corporation from mining company to a

manufacturer of superalloy castings for aircraft and industrial uses and aluminum products for

the building, packaging and aircraft industries. Sales were evenly divided between castings and

aluminum products.

Crown’s castings were for the most part designed for operation in the “hot part” of the gas

turbine engine. Crown’s constant emphasis on quality and technical excellence had established

a high level of confidence among its customers. The other half of crown’s sales comprised

aluminum products, including a broad product line for the building and construction industry. To

assure a steady and economical source, Crown Corporation participated with American Metal

climax, Inc. in a project in 1966 known as Intalco, which made them a producer of primary

aluminum. Crown’s share of Intalco’s output was 130 million pounds. Crown decided to build a

second aluminum ingot plant in 1967, named Eastalco, which provide Crown with additional

primary aluminum capacity of 85 million pounds a year and increased net income of $3-4

million. A planned addition of 85 million pounds in 1972 would raise Eastalco’s capacity to 170

million pounds and would meet the company’s objective to be a fully integrated producer.

Crown’s sales performance was good initially, it’s sales had risen sharply from $60 million in

1958 to $230 million in 1968 on the strength of 23 acquisitions, strong internal growth and a

firming of aluminum prices. But after some time it faces some bad turns, after reaching a peak

of $1.13 in 1959, earnings per share fell to $0.34 in 1963 as overcapacity developed in the

aluminum business. During that time domestic industry capacity roses and growth potential in

the industry encouraged new producers to enter into the market. So overcapacity developed

and therefore, price falls down. Producers sold their product in low rate to grab the market. But

demand-supply conditions in the industry improved in the early 1960s. with this improvement

higher earnings came for Crown and other aluminum producers in the industry. But some

producers were still maintaining lower prices to obtain business for their idle machine. When

producers started getting consumers and order from them they rose the prices slowly, and soon

the industry price situation improved after 1968, whereas process of fabricated products

remained weak until 1965.

Page 3: Crown Corporation Case Solution - HBS 273-086

Problem Definition

In February 1969 Mr. Walter Bennet, treasurer of Crown Corporation was considering several

financing alternatives. Crown’s decision to integrate backwards into the production of primary

aluminum ingot had resulted in very heavy capital expenditures. Its need for funds for working

capital and for completion of Eastalco now outstripped the company’s internal cash generation

and it would be necessary to raise $30 million within the next 6 months to cover capital needs

for 1969.

Expected Growth and Estimated Capital Expenditures

Mr. Walter Bennett, treasurer of Crown Corporation expected that sales would increase at 6-8%

annually, exclusive of acquisitions, over the foreseeable future. Sales of aluminum products

were expected to rise by 15-20% annually as the company broadened its penetration of major

aluminum consuming markets. Total capital expenditures, including the Eastalco project, were

forecast at $39 million in 1969, $32 million in 1970, $7 million in 1971 and $50 million in 1972.

The heavy capital spending would require that Crown raise $30 million in 1969, $22 million in

1970 and $30 million in 1972.

Financing Alternatives

Several alternatives were open to Crown to meet its financing need. Mr. Bennett were

considering those alternatives. The company’s investment banker’s pointed to the future

financing flexibility afforded by the use of equity financing, by issuing $30 million common stock,

but the dilution of earnings per share were the matter of concern for Bennett. Because Crown

stock had fallen from $51 a share in May 1968 to $30 a share. Investors were disappointed with

the earnings. Further near-term price weakness seemed likely as earnings per share remained

depressed as Crown absorbed heavy startup costs for the production of the main landing gear

for the McDonnel Douglas DC-10 in 1969. Under this conditions, announcement of a large

equity issue would drive stock price down to the low twenties. For that reason it would be

necessary to sell 1.4 million shares to rise the $30 million net to the company. So Mr. Bennett

was confused whether equity financing should deferred until the company get back to pattern of

earnings gains.

Page 4: Crown Corporation Case Solution - HBS 273-086

Alternative to equity financing was to take bank loans. A consortium of commercial banks had

agreed to lend the company up to $30 million at 7-1/4% interest. But there were some

conditions like net working capital must exceed $55 million, dividend payments were restricted

to earnings accumulated after the date of the loan agreement and additional funded debt was

limited to $20 million.

Another alternative could be issuing debentures. It would be possible to place a $30 million

subordinated convertible debenture issues privately with the Northern Life Insurance Company.

The debenture would carry a coupon of 6% with annual debt retirement of $2 million in years six

through twenty. The issue would not be callable for ten years, except at par for mandatory debt

retirement, and would be convertible into common stock.

Other than these Mr. Bennett was interested in the debt alternatives, although the company’s

use of debt had increased sharply.

Page 5: Crown Corporation Case Solution - HBS 273-086

Financial Statements

Income Statement

Crown CorporationIncome Statements for the years 1962-1968 (Figures in $ Millions Except Per Share data)

1962 1963 1964 1965 1966 1967 1968

Net Sales 110.00 122.00 122.00 141.00 176.00 213.00 230.00

Cost of Sales and Overheads 101.70 117.40 116.50 128.24 153.00 180.50 196.50Depreciation 4.50 4.70 5.00Operating Profit 8.30 4.60 5.50 12.76 18.50 27.80 28.50Financial Income 2.48Financial Expenses 3.48Other Income (Expense) (0.40) (0.60) (0.30) (0.80) (0.10) (0.70) (1.00)

Income before taxes 7.90 4.00 5.20 11.96 18.40 27.10 27.50

Federal Income Taxes 3.70 1.50 2.30 3.60 7.60 12.30 13.80Net Income 4.20 2.50 2.90 8.36 10.80 14.80 13.70Dividends 0.00 1.45 1.45 1.67 2.91 4.36 5.09

Retained Earnings 4.20 1.05 1.45 6.69 7.89 10.44 8.61Per Share Data

Earnings 0.57 0.34 0.42 0.66 1.50 2.03 1.87

Dividends 0.00 0.20 0.20 0.23 0.40 0.60 0.70Dividends accrued 0.00 1.45 1.45 1.67 2.91 4.36 5.09No. of Shares (in Millions) 7.273 7.273 7.273 7.273 7.273 7.273 7.273Market PriceHigh 9.00 7.00 7.00 11.00 27.00 51.00 51.00Low 5.00 5.00 5.00 6.00 10.00 22.00 32.00

Price Earnings RatioHigh 16.00 21.00 17.00 17.00 18.00 25.00 27.00Low 9.00 15.00 12.00 9.00 7.00 11.00 17.00

Page 6: Crown Corporation Case Solution - HBS 273-086

Balance Sheet

Crown CorporationBalance Sheets for the Years 1965-1968 (Figures in $ Millions)

1965 1966 1967 1968AssetsCash 3 3 5 4Marketable Securities 7 10 23 6Accounts Receivable 20 23 35 42Inventories 28 38 45 50Other 0 0 1 1Total Current Assets 58 74 109 103

Investment in aluminum plantsIntalco 32 29 34 36

Eastalco 0 0 0 4Other Net property, plant and equipment 28 31 34 42

Other 3 4 4 4Gross Fixed Assets 91Depreciation 5Net Fixed Assets 63 64 72 86

Total Assets 121 138 181 189

LiabilitiesAccounts Payable 8 10 13 14Accrued liabilities 6 7 7 10

Accrued Taxes 4 8 8 6

Dividends payable 1 1 1 1Current Maturities - Long Term Debt 2 2 2 4Total current liabilities 21 28 31 35

Long term debt 30 28 56 52Deferred federal taxes 1 2 3 3Stockholders' equity (7,273,000 shares outstanding atyear end 1968)

69 80 91 99

Total Liabilities and net worth 121 138 181 189

Page 7: Crown Corporation Case Solution - HBS 273-086

Q1. PROJECT CROWN’S INCOME STATEMENTS AND BALANCE SHEETS FOR THE YEARS 1969-1972

We are considering two pro-forma statements for Crown Corporation, one by full equity

financing, and other by full debt financing by debentures.

Assumptions for projected financial statements:

The Intalco project started from 1966, therefore in case of calculating the averages, we have

considered 3 years of data, 1966-1968

Income Statement Items

1. Sales – As it was given that the sales will increase 6-8% annually. We took 7% increase

annually as an average.

2. Cost of sales and overheads – Income statements gives us the operating profit from

where we can calculate the cost of sales and overheads including the depreciation.

However, in 1968 we have got the figure of depreciation of 5 million. Therefore we can

calculate the cost of sales and overheads excluding depreciation, and take the

percentage.

3. Depreciation – for ‘68 it is $5m. Before ’68, we assume that depreciation will be little less

than 5 million. For the projected income statements, we took 20 years life for each of the

capital expenditures as it is an industrial capital expenditure. Therefore new depreciation

will be 5% of the capital expenditure in addition to the $5 million from previous

investments.

4. Other Income (Expenses) – We have spited the other income (expenses) in 2 parts,

financial income and financial expenses. For the financial expense in ’68, we have got

the figure from the issuance of new debentures of $56m @6% coupon rate, therefore we

calculated the financial income from ’68 as a percentage of sales and applied

accordingly. Financial expenses for the projected income statement will change on the

financing decisions, the rate will be constant @6%.

5. Tax Rate - 45.62%

6. Dividends – Dividends will have a rate of $0.70 and it cannot be jeopardized. Therefore

in case of both debt financing and equity financing, we considered 70 cent dividend rate.

Page 8: Crown Corporation Case Solution - HBS 273-086

Balance Sheet Items

1. Current assets – All the items in the current assets (except other) were treated by the

percentage of sales. The “Other” item was kept at $1m as it was for the previous two

years.

2. Fixed assets – Crown will have heavy capital expenditures for the following years. The

total figure for capital expenditures were given, but couldn’t be identified that which

project will have what amount of investment. So from 1969 we have added the capital

expenditures to the total fixed assets and considered depreciation @5%.

3. Current Liabilties – Accounts payable, accrued liabilities and accrued taxes were treated

as the percentage of sales. Dividends were constant at 1m for the last 4 years, so we

kept it that way. For the current maturity of long term debt, from 1968 we are having debt

retirement of $4m. If we finance by equity, there will be no change in it, and if we finance

by debentures, there will also be no change because the debt retirement for new

debentures will be effective after 5 years.

4. Long Term Debt - Changes according to financing decision

5. Deferred tax liability - Treated as the adjustment in balance sheet

6. Shareholders equity – Changes with financing decision.

Financing Alternatives

a. Equity Financing – For equity financing, we have considered $21.43 per share and the

no. of shares will increase accordingly to the amount of financing

b. Debt Financing – For all the three finances we are considering debentures @ 6%

coupon rate with the debt retirement facilty of $ starting in 6th year.

Page 9: Crown Corporation Case Solution - HBS 273-086

Forecasted Financial Statements by Equity Financing

Crown CorporationProjected Income Statements by Equity Financing (Figures in $millions except per share data)

1969 1970 1971 1972

Net Sales 246.10 263.33 281.76 301.48

Cost of Sales and Overheads 209.19 223.83 239.50 256.26

Depreciation 6.95 8.55 8.90 11.40

Operating Profit 29.97 30.95 33.36 33.82Financial Income 2.66 2.84 3.04 3.26

Financial Expenses 3.36 3.12 2.88 2.64

Other Income (Expense) (0.70) (0.28) 0.16 0.62

Income before taxes 29.26 30.67 33.53 34.44

Federal Income Taxes 13.35 13.99 15.30 15.71

Net Income 15.91 16.68 18.23 18.73

Dividends 6.07 6.79 6.79 7.77

Retained Earnings 9.84 9.89 11.44 10.96

Per Share DataEarnings 1.83 1.72 1.88 1.73

Dividends 0.70 0.70 0.70 0.70Dividends accrued 6.07 6.79 6.79 7.77No. of Shares (in Millions) 8.673 9.700 9.700 10.800

Page 10: Crown Corporation Case Solution - HBS 273-086

Crown CorporationProjected Balance Sheets by Equity Financing (Figures in $ Millions)

1969 1970 1971 1972AssetsCash 4.75 5.08 5.44 5.82Marketable Securities 15.65 16.75 17.92 19.17

Accounts Receivable 39.18 41.92 44.86 48.00

Inventories 52.89 56.59 60.55 64.79

Other 1.00 1.00 1.00 1.00Total Current Assets 113.47 121.34 129.76 138.78

Gross Fixed Assets 125.00 150.05 148.50 189.60Depreciation 6.95 8.55 8.90 11.40Net Fixed Assets 118.05 141.50 139.60 178.20

Total Assets 231.52 262.84 269.36 316.98

LiabilitiesAccounts Payable 14.67 15.69 16.79 17.97

Accrued liabilities 9.52 10.19 10.90 11.67

Accrued Taxes 8.96 9.59 10.26 10.97

Dividends payable 1.00 1.00 1.00 1.00Current Maturities - Long Term Debt 4.00 4.00 4.00 4.00

Total current liabilities 38.15 40.47 42.95 45.61

Long term debt 48.00 44.00 40.00 36.00Deferred federal taxes 6.53 5.94 2.67 10.80Stockholders' equity 138.84 172.43 183.74 224.57

Total Liabilities and net worth 231.52 262.84 269.36 316.98

Page 11: Crown Corporation Case Solution - HBS 273-086

DEBT MANAGEMENT RATIOS 1969 1970 1971 1972

1. Long Term Debt Ratio = Long TermDebt/Total assets

0.225 0.183 0.163 0.126

Long Term Debt 52.000 48.000 44.000 40.000

Total Assets 231.518 262.840 269.364 316.978

2. Debt Equity Ratio=Long TermDebt/Owner's Equity

0.375 0.278 0.239 0.178

Long Term Debt 52.000 48.000 44.000 40.000

Owner's Equity 138.840 172.427 183.738 224.565

PROFITABILITY RATIOS 1969 1970 1971 1972

1. Net Profit Margin = Net Profit AfterTax/Sales

0.065 0.070 0.064 0.062

Net Profit 15.913 18.377 18.101 18.597

Sales 246.100 263.327 281.760 301.483

2. Operating Profit Margin = OperatingProfit/Sales

0.122 0.118 0.118 0.112

Operating Profit/EBIT29.965 30.949 33.364 33.822

Sales 246.100 263.327 281.760 301.483

3. Return on Assets = Net Profit /TotalAssets 0.069 0.070 0.067 0.059

Net Profit 15.913 18.377 18.101 18.597

Total Assets 231.518 262.840 269.364 316.978

4. Return on Equity = Net Profit /Stokholder's Equity 0.115 0.107 0.099 0.083

Net Profit 15.913 18.377 18.101 18.597

Stockholder's Equity 138.840 172.427 183.738 224.565

Page 12: Crown Corporation Case Solution - HBS 273-086

5. Payout Ratio = DividendsDeclared/Net Profit After Tax

0.381 0.369 0.375 0.418

Dividends Declared 6.070 6.790 6.790 7.770

Net Profit 15.913 18.377 18.101 18.597

6. Plowback Ratio = 1 - Payout Ratio 0.619 0.631 0.625 0.582

Payout ratio 0.381 0.369 0.375 0.418

MARKET VALUE RATIOS 1969 1970 1971 1972

1. Earnings Per Share= NetIncome/Outstanding No. of Shares

1.835 1.894 1.866 1.722

Net profit 15.913 18.377 18.101 18.597

Outstanding Shares 8.673 9.700 9.700 10.800

2. Book Value Per Share=TotalEquity/Outstanding No. of Shares

16.008 17.776 18.942 20.793

Total Equity 138.840 172.427 183.738 224.565

Outstanding No. of Shares 8.673 9.700 9.700 10.800

Page 13: Crown Corporation Case Solution - HBS 273-086

Forecasted Financial Statements by Debt Financing

Crown CorporationProjected Income Statements (Debt Financing by Debentures) (in $ millions)

1969 1970 1971 1972

Net Sales 246.10 263.33 281.76 301.48

Cost of Sales and Overheads 209.19 223.83 239.50 256.26

Depreciation 6.95 8.55 8.90 11.40

Operating Profit 29.97 30.95 33.36 33.82Financial Income 2.66 2.84 3.04 3.26Financial Expenses 3.36 4.92 6.00 5.76Other Income (Expense) (0.70) (2.08) (2.96) (2.50)

Income before taxes 29.26 28.87 30.41 31.32

Federal Income Taxes 13.35 13.17 13.87 14.29

Net Income 15.91 15.70 16.54 17.03Dividends 5.09 5.09 5.09 5.09

Retained Earnings 10.82 10.61 11.45 11.94

Per Share Data

Earnings 2.19 2.16 2.27 2.34

Dividends 0.70 0.70 0.70 0.70Dividends accrued 5.09 5.09 5.09 5.09

Page 14: Crown Corporation Case Solution - HBS 273-086

Crown CorporationProjected Balance Sheets (Debt Financing by Debentures)

1969 1970 1971 1972AssetsCash 4.75 5.08 5.44 5.82

Marketable Securities 15.65 16.75 17.92 19.17

Accounts Receivable 39.18 41.92 44.86 48.00

Inventories 52.89 56.59 60.55 64.79

Other 1.00 1.00 1.00 1.00Total Current Assets 113.47 121.34 129.76 138.78

Gross Fixed Assets 125.00 150.05 148.50 189.60Depreciation 6.95 8.55 8.90 11.40Net Fixed Assets 118.05 141.50 139.60 178.20

Total Assets 231.52 262.84 269.36 316.98

LiabilitiesAccounts Payable 14.67 15.69 16.79 17.97

Accrued liabilities 9.52 10.19 10.90 11.67

Accrued Taxes 8.96 9.59 10.26 10.97

Dividends payable 1.00 1.00 1.00 1.00Current Maturities - Long Term Debt 4.00 4.00 4.00 4.00

Total current liabilities 38.15 40.47 42.95 45.61

Long term debt 78.00 96.00 92.00 118.00Deferred federal taxes 5.55 5.94 2.53 9.55Stockholders' equity 109.82 120.43 131.88 143.82

Total Liabilities and net worth 231.52 262.84 269.36 316.98

Page 15: Crown Corporation Case Solution - HBS 273-086

DEBT MANAGEMENT RATIOS 1969 1970 1971 1972

1. Long Term Debt Ratio = Long TermDebt/Total assets

0.354 0.380 0.356 0.385

Long Term Debt 82.000 100.000 96.000 122.000

Total Assets 231.518 262.840 269.364 316.978

2. Debt to Equity Ratio=Long TermDebt/Owner's Equity

0.747 0.830 0.728 0.848

Long Term Debt 82.000 100.000 96.000 122.000

Owner's Equity 109.820 120.431 131.876 143.817

PROFITABILITY RATIOS 1969 1970 1971 1972

1. Net Profit Margin = Net Profit AfterTax/Sales

0.065 0.060 0.059 0.056

Net Profit 15.913 15.701 16.535 17.031

Sales 246.100 263.327 281.760 301.483

2. Operating Profit Margin = OperatingProfit/Sales

0.122 0.118 0.118 0.112

Operating Profit/EBIT29.965 30.949 33.364 33.822

Sales 246.100 263.327 281.760 301.483

3. Return on Assets = Net Profit /TotalAssets

0.069 0.060 0.061 0.054

Net Profit 15.913 15.701 16.535 17.031

Total Assets 231.518 262.840 269.364 316.978

4. Return on Equity = Net Profit /Stokholder's Equity 0.145 0.130 0.125 0.118

Net Profit 15.913 15.701 16.535 17.031

Stockholder's Equity 109.820 120.431 131.876 143.817

Page 16: Crown Corporation Case Solution - HBS 273-086

5. Payout Ratio = DividendsDeclared/Net Profit After Tax

0.320 0.324 0.308 0.299

Dividends Declared 5.090 5.090 5.090 5.090

Net Profit 15.913 15.701 16.535 17.031

6. Plowback Ratio = 1 - Payout Ratio 0.680 0.676 0.692 0.701

Payout ratio 0.320 0.324 0.308 0.299

MARKET VALUE RATIOS 1969 1970 1971 1972

1. Earnings Per Share= NetIncome/Outstanding No. of Shares

2.188 2.159 2.274 2.342

Net profit 15.913 15.701 16.535 17.031

Outstanding Shares 7.273 7.273 7.273 7.273

2. Book Value Per Share=TotalEquity/Outstanding No. of Shares

15.100 16.559 18.132 19.774

Total Equity 109.820 120.431 131.876 143.817

Outstanding No. of Shares 7.273 7.273 7.273 7.273

Page 17: Crown Corporation Case Solution - HBS 273-086

Interpretation of the ratio analysis

Net Profit Margin

1969 1970 1971 1972

Equity Financing0.065 0.070 0.064 0.062

Debt Financing0.065 0.060 0.059 0.056

In equity financing, the net profit margin is little higher than the debt financing. It is a result of

reduced amount of interest expense.

Return on Equity (ROE)

1969 1970 1971 1972

Equity Financing0.115 0.107 0.099 0.083

Debt Financing0.145 0.130 0.125 0.118

For Debt financing, the return over equity increases significantly over the years.

Dividend Payout Ratio

1969 1970 1971 1972

Equity Financing0.381 0.369 0.375 0.418

Debt Financing0.320 0.324 0.308 0.299

Dividend payout ratio increases in equity financing because the no. of shares will increase and

the payout remaining constant at 70 cents per share.

Page 18: Crown Corporation Case Solution - HBS 273-086

Long Term Debt Ratio

1969 1970 1971 1972

Equity Financing0.225 0.183 0.163 0.126

Debt Financing0.354 0.380 0.356 0.385

After all the financing, the long term debt is 38.5% in 1972, which is still lowest in the industry.

Earnings per share

1969 1970 1971 1972

Equity Financing1.835 1.894 1.866 1.722

Debt Financing2.188 2.159 2.274 2.342

The most significant change in debt and equity financing is the earnings per share. In equity

financing, the no. of stocks increases in ’69, ’70, and ’72 which diluted the no. of shares rapidly

and the earning per share keep declining in equity financing whereas earnings per share keep

increasing debt financing.

Page 19: Crown Corporation Case Solution - HBS 273-086

Q2. RECOMMEND AND DEFEND THE FINANCING DECISIONS THAT CROWN’S MANAGEMENT SHOULD

MAKE IN 1969?

Mr. Walter Bennet, treasurer of Crown Corporation has 3 alternatives to meet the company’s

financial needs of $30m in 1969.

1. Equity financing by selling 1.4 million shares for $30 million.

2. Lending from commercial banks at an interest rate of 7.25%, repayable at an annual rate

of $5 million beginning in 1970 and ending in 1975. Additional funded debt limited to 20

million and restrictions on dividend payments.

3. Convertible debenture issue privately with Northern Life Insurance Company at a

coupon rate of 6% and annual debt retirement of $2m starting in year six through twenty.

Debentures can be converted after ten years @$31.50 per share.

Out of the three alternatives, the second alternative is left out at beginning without any analysis

as because since Crown have another debt alternative at a lower rate with debt retirement

facility for 20 years. Therefore we were left with two alternatives, debt financing with debentures

or equity financing.

Theoretically, we always know that cost of equity is always the highest as it doesn’t give any tax

benefit and also the investors demand higher returns. Here in Crown’s case, if we issue 1.4

million shares to raise 30 million, no. of shares will be diluted and earnings per share will

decline. This may have an adverse effect on the future and the market price of shares may go

down due to the declination in EPS. The dividend policy is 70 cent per share, and equity

financing will increase the payment of dividends as the no. of shares will increase. Therefore the

retained earnings will decrease due to the increased amount of dividend payments. In equity

financing the profit before tax rises by a little margin due to the reduced interest payments but

that also results in high tax payments.

The third alternative, going for issuing convertible debentures @6% coupon rate with Northern

Life Insurance with a debt retirement facility of $2m per year starting from sixth year seems a

very lucrative alternative. It is giving 5 years of flexibility, which means we don’t have to pay any

principal amount and we can use the whole debt for our capital expenditure needs and increase

the production. The convertible debentures can also be converted into equity stocks after 10

years @31.5 per share.

Page 20: Crown Corporation Case Solution - HBS 273-086

Our recommended decision for Crown Corporation is that they should go for debt financing with

convertible debentures with Northern Life Insurance. This will give us a tax benefit, dividend

payments will not increase, retained earnings will increase hence increasing the shareholders’

equity, earnings per share will increase, and as a result, the market value per share of Crown

Corporation is expected to increase.

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.

After the financial decision taken in 1969 to issue convertible debentures, Crown Corporation

needs another $22 million in 1970 and $30 million in 1972. Crown Corporation will be needing

the following capital expenditures:

1. $39 Million in 1969

2. $32 Million in 1970

3. $7 Million in 1971

4. $50 Million in 1970

This indicates that Crown Corporation is going for heavy industrial investment over the next few

years. One major reason for this is to complete the Eastalco project and raise the capacity to

170 million pounds of primary aluminum by 1972. Once the Eastalco project is completed,

Crown Corporation will become a fully integrated producer of aluminum and will have surplus

primary aluminum to sell. In total the sales will boost up in 1973 and cost of production will be

less.

Crown Corporation is a renowned company in aluminum industry. The most important

competitive advantage for them is the trust of the customers is so high due to their quality and

technical excellence.

If we look at the present situation of the industry, then it is found that the price of ingot has risen

several times since 1961. Current price of ingot is $0.27 per pound.

There was labor issue which was solved in 1968 and the production seems to be stable.

Page 21: Crown Corporation Case Solution - HBS 273-086

If Crown Corporation go for all the capital expenditures in the upcoming years to make it a fully

integrated producer through technological advancements, Crown Corporation will be able to

boost up their sales by 1973 and additionally they will be able to sell the surplus primary

aluminum at a higher rate.

For the finance requirement in 1969 and 1970, it will be lucrative to go for convertible

debentures so the share price will not be diluted and hence increasing the firm value. After their

successful operation in the three years, in 1972 the price of share is expected to rise as it will

gain the trust of the investors. Anticipated sales figures will increase at a higher rate in 1973.

Therefore in 1972, to fulfill the finance requirement of $30 million, Crown Corporation may go for

equity financing instead of debt financing as the company will already have large amount of debt

for their previous borrowing. So in case of new debt, the lenders will demand higher interest

which will also increase the interest payments.

If the market price of share goes high, Crown will be able to raise $30 million by issuing less no.

shares and dilution will not be very significant and hence the EPS is not expected to fall

significantly. The rise in the payment of dividends will be lower and will not have much effect in

the retained earnings. We assume that we will be able to raise $30m by issuing 700,000 shares.

Therefore the action plan for Crown Corporation for the financing requirements in next 3-5

years:

Borrow in form of convertible debentures in 1969, and 1970

Go for fully integrated production

Imaginative research and development program for introducing new product line

Aggressive marketing strategy to grab new market share

Finance by issuing new shares in 1972

Page 22: Crown Corporation Case Solution - HBS 273-086

Debt and Equity Financing Pro Forma Statements

Projected Income Statements (Debt Financing in 69, 70, and Equity Financing in 72) (In $m)1969 1970 1971 1972

Net Sales 246.10 263.33 281.76 301.48

Cost of Sales and Overheads 209.19 223.83 239.50 256.26

Depreciation 6.95 8.55 8.90 11.40

Operating Profit 29.97 30.95 33.36 33.82Financial Income 2.66 2.84 3.04 3.26Financial Expenses 3.36 4.92 6.00 5.76Other Income (Expense) (0.70) (2.08) (2.96) (2.50)

Income before taxes 29.26 28.87 30.41 31.32

Federal Income Taxes 13.35 13.17 13.87 14.29

Net Income 15.91 15.70 16.54 17.03Dividends 5.09 5.09 5.09 5.58

Retained Earnings 10.82 10.61 11.45 11.45

Per Share Data

Earnings 2.19 2.16 2.27 2.14

Dividends 0.70 0.70 0.70 0.70Dividends accrued 5.09 5.09 5.09 5.58No.of shares (in millions) 7.273 7.273 7.273 7.973

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Projected Balance Sheets (Debt Financing in 69, 70, and Equity Financing in 72) (in $m)1969 1970 1971 1972

AssetsCash 4.75 5.08 5.44 5.82

Marketable Securities 15.65 16.75 17.92 19.17

Accounts Receivable 39.18 41.92 44.86 48.00

Inventories 52.89 56.59 60.55 64.79

Other 1.00 1.00 1.00 1.00Total Current Assets 113.47 121.34 129.76 138.78

Gross Fixed Assets 125.00 150.05 148.50 189.60Depreciation 6.95 8.55 8.90 11.40Net Fixed Assets 118.05 141.50 139.60 178.20

Total Assets 231.52 262.84 269.36 316.98

LiabilitiesAccounts Payable 14.67 15.69 16.79 17.97

Accrued liabilities 9.52 10.19 10.90 11.67

Accrued Taxes 8.96 9.59 10.26 10.97

Dividends payable 1.00 1.00 1.00 1.00Current Maturities - Long Term Debt 4.00 4.00 4.00 4.00

Total current liabilities 38.15 40.47 42.95 45.61

Long term debt 78.00 96.00 92.00 88.00Deferred federal taxes 5.55 5.94 2.53 9.55Stockholders' equity 109.82 120.43 131.88 173.82

Total Liabilities and net worth 231.52 262.84 269.36 316.98

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Appendix