- Their first decision is to determine if they can profit from this venture
- Their after-tax weighted average cost of capital
- The change in net working capital
- The company five years later
Luxury Automotive Supply is trying to enter the California market which represents a lucrative market for automobiles owing to its pleasant climate. As the company's luxury automobiles are driven throughout the year due to the climate, the company feel the annual demand for car parts will be similar to that of Florida market.
1) The company's first step is to determine if it can profit from this venture, so it must perform a break-even analysis. The warehouse and office space which the company will rent will cost $12,500 in terms of monthly rent and utilities. It will hire two full-time employees who will earn $1,500 per month and this will cost the company 25% more in health care benefits. In order to market and advertise the new business, the company estimates an annual budget of $4,500 per month for advertisements on television, radio, newspaper as well as a website where orders can be placed. Other miscellaneous operating expenses will be $1,000 per month. The company will finance the move into California by taking $100,000 of equity out of its stock market investment account which earns 18% per year and taking out a small business loan of $50,000 at 12% annual interest rate (1% per month). To build up its inventory, the required auto parts will cost an average of $125 each. In order to realize profits, the company will sell the parts for $215 each. We will calculate how many parts the company needs to sell each month in order to break even, i.e., to reach a net income of zero.
[...] Advantages Disadvantages Issuing Bonds - the interest on bonds - interest should be paid and other debt is regularly deductible on the interest payments and corporation's income tax return principal at a return determined date the ownership interest - bonds are an increase in the corporation will in debt, they may not be diluted by adding adversely affect the more owners market's perception of the management retains the company control as the bondholders - the bond's face value cannot vote must be repaid on the maturity date bonds are only a temporary source of financing, and after they are paid off, the debt is eliminated bonds can be paid back early if they are issued with a call provision and often bonds can be convertible to common stock Issuing Common - stock price never has to - not deductible on the Stock be repaid as stockholders income tax return are owners of the company - the stockholders become there is no legal owners of the firm and obligation to pay can affect its management dividends by voting for the Board no debt is incurred, so of Directors the company is financially - it is more costly to stronger pay dividends, as they are paid after taxes managers may be tempted to make stockholders happy in the short term rather than plan for long-term needs When potential new investors decide whether or not to purchase shares in the company, they are likely to use the Capital Asset Pricing Model. [...]
[...] The business is going so well that the owners have been able to borrow large amounts of money from their bank and open five new stores throughout California. Now, they want to expand into Nevada and Arizona, but the bank is not willing to lend them $750,000 which they need. In order to expand further, they would need to raise money from the public, either through issuing bonds or issuing shares. If they decide to issue bonds, how will the interest rate that Luxury Automotive Supply has to pay on the bonds be determined? [...]