User Account

All Pages

Touring Enterprises, Corporate Finance

Assignment Help:



As the company''s sales and earnings increased, so did the demand for capital. The firm''s needs included inventory as well as additional space to house the inventory, computer facilities, and order processing areas. In the late 1980s the firm decided to include in its business some light fabrication of certain parts. The purpose of this was to handle customers'' needs for specialty items. Such items were generally those made of fiberglass or aluminum. On-premises fabrication of such items gave the firm the ability to purchase parts from a wider array of suppliers without the constraints imposed by concerns for fit, style, color, and the like.

The recent growth, however, had placed severe demands on the firm''s ability to manage all aspects of its finances. Mettway had formed solid relationships with banks and other lenders, and the firm''s stock had been traded on a regional stock exchange since the initial public offering in 1978. As the firm''s strategic plan indicated the desirability of a new facility on the East Coast, Mettway''s attention turned increasingly to a careful articulation of an internal financial policy. The policy would serve as a guideline for acquiring capital in the short-term as well as during and after the establishment of a new business location.

Of specific concern to the company''s treasurer was the matter of how to communicate to the firm''s financial analysts and accountants the proper manner in which to calculate the weighted average cost of capital. The desire was to not only have the concept widely understood by all financial staff members, but to understand how the current liabilities and depreciation fit into the calculations, if at all. The firm''s balance sheet is shown in Table 1.






Table 1



Touring Enterprises

Balance Sheet

December 31, 1995

($000s)






Month




1993





Forecasted

for 1994


















Cash


$810


Bank loans


$1,830




Marketable securities


2,647


Accounts payable


1,070




Account receivable


2,500


Accrued expenses


1,763




Inventory


8,519


Current maturities of long-term debt




460




Re-Paid expenses


500










Total current assets


$14,976


Total current liabilities


$5,123
























Long-term debt


4,600










Total liabilities


$9,723




Gross fixed assets


$13,343










Less: Accumulated

Depreciation*




(5,499)




Common stock




$2,024




Net fixed assets


7,844


Paid-in capital


3,952




Other assets


677


Retained earnings


7,798




Total assets


$23,497


Common equity


$13,774










Total liabilities and equity




$23,497


*Annual accumulated depreciation, approximately $400,000 for the past 3 years.

What concerned Mettway was the unspecific nature of certain aspects of the cost of capital calculation in practice - that is, how best to present the general rules of cost of capital in a manner that the finance staff would see as logical and widely applicable. The firm''s cost of funds obtained through a stock issuance or offering of long-term debt was relatively easy to assess. At present the firm''s stock price was $22 and the annual dividend was $1.10. Further, the yield on debt of the type that Touring Enterprises had recently issued was 7.5 percent. The firm was in the 35 percent tax bracket. (This included federal, state, and local taxes.)

The bank loans shown Table 1 were revolving lines of credit, which the firm maintained at a relatively constant level of draw-down year to year. The same was true for accrued wages and taxes, and accounts payable. Mettway recognized that textbook expositions of the weighted average cost of capital exhibited a (necessarily) simplistic approach, which showed the interrelationship among equity, long-term debt, and the total of those two as the basis for the weighted average capital cost calculation. However, the operating practices of firms differed across industries and among firms within the same industry. Such differences often influenced capital cost calculation. The primary causes of such differences were capital structure, composition and level of current liabilities and depreciation, and the firm''s effective tax rate. Mettway believed that developing a clear policy on the firm''s cost of capital calculation would require careful consideration of the specific operating characteristics of Touring Enterprises.

The company''s treasurer understood that the inclusion of current liabilities in the firm''s financial planning affected the capital budget. Mettway knew that in any period the amount of external funds at a given cost would be influenced by the inclusion or exclusion of current liabilities. For example, if Touring Enterprise used accelerated depreciation for its tax reporting, and straight line depreciation for reporting income to stockholders, a deferred tax (a current liability) charge would appear on the report to stockholders. Deferred taxes are a noncash charge; therefore, net income, but not net cash flow, would be altered due to the difference in depreciation.

QUESTIONS:

1. What is the major value of the weighted cost of capital calculation for the firm?

2. Describe *capital structure*

3. How is the firm''s weighted cost of capital influence by the firm''s capital structure?

4. Describe the role of the firm''s tax rate in cost of capital calculations?

5. Calculate the cost of long term debt and common equity for Touring Enterprises. Calculate the weighted average cost of capital.

6. Provide an argument for including or not including current liabilities in the cost of capital calculation.

7. Touring Enterprises'' capital structure is believed to be optimal. What is the meaning and importance of an optimal capital structure to the cost of capital calculation?

8. What economic circumstances will likely cause a change in the firm''s optimal capital structure?

9. Explain the effect of accelerated depreciation versus straight-line upon net income. How does this create "deferred taxes" on the firm''s balance sheet?

10. Should Touring Enterprises consider liabilities as a part of its permanent financing? Why or why not?

Related Discussions:- Touring Enterprises

Calculate the net present value, Here is the pro-forma income statement for...

Here is the pro-forma income statement for Semen Indonesia, an overseas venture that Cemex is planning to invest in.  In this exercise, you will need to evaluate the inve

Mergers had on fees assessed for retail bank services?, What effects have m...

What effects have mergers had on fees assessed for retail bank services? A: The impact is not clear. Market conditions and the level of competition often determine the cost for

IRR & WACC, I have been given 3 different types of projects. They state th...

I have been given 3 different types of projects. They state the IRR and how much the project will add. The question goes on to give a WACC with break points. The question wants

Mergers & Acquisitins, Relationship between the size of companies and the r...

Relationship between the size of companies and the role of M & A

Replacement decision, #question.Baobab rolling mills owns a lathe machine w...

#question.Baobab rolling mills owns a lathe machine which was purchased 10years ago at sh. 75 million. The machine had an expected life of 15 yrs at the time it was purchased, and

Replacement decision, Baobab rolling mills owns a lathe machine which was p...

Baobab rolling mills owns a lathe machine which was purchased 10years ago at sh. 75 million. The machine had an expected life of 15 yrs at the time it was purchased, and management

Illustrate a stakeholder mapping matrix, Many strategic decisions fail be...

Many strategic decisions fail because they do not attend to the interests and information held by key stakeholders. This scenario has prompted a stakeholder's approach to cor

Bond valuation, An investor buys a French government, 10-year bond, paying ...

An investor buys a French government, 10-year bond, paying annual coupon of 4.5%. Face value = 1000. The investor is unsure of his investment horizon and considers 5 horizons: 5, 6

Wacc, The cost of capital for a firm can differ from the cost of capital fo...

The cost of capital for a firm can differ from the cost of capital for each of its businesses. When a firm has multiple businesses, it is important to use the cost of capital appro

Explain what you understand by the term access controls, Question : (a)...

Question : (a) Electronic banking can be defined as "the automated delivery of new and traditional banking products and services directly to customers through electronic, int

Write Your Message!

Captcha
Order Assignment

Featured Services

Order Now

Popular Subjects

Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

Submit Assignment

Academics

Major Subjects

Majors

Get In Touch

whatsapp: +91-977-207-8620

Phone: +91-977-207-8620

Email: [email protected]

TERMS & POLICIES

HELP & SUPPORT

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd