JET2 Task 3
A1. Capital Structure Recommendation
A sound capital structure needs to be in place for Competition Bikes to maximize its shareholder return and expand. A good capital structure would ensure adequate funding and future business stability. However, adequate funding involves capital financing which also has its own risks. If bonds are issued, the company would have to pay interest on them but if sales projections aren’t met, this could have a huge negative impact on shareholder earnings. Also dividends could be impacted if no shares issued to cover growth or expansion costs because profits will have to be spread among larger number of shares. To provide a base for analysis in comparing all structures, 5 capital sources have been reviewed as well as the earnings per common share for years nine through 13 were calculated. I will recommend a 50 percent preferred stock and 50 percent common stock capital structure to raise $600,000 required to expand to into Canada. It will maximize investor’s return on investment to highest total earnings per share from year 9 to 13. It will result in to a highest income before taxes because no bond will be due with this structure. After paying the taxes, common shares would yield the highest total income – leading to the highest earnings per common share. This structure also led to the lowest shares issued which is a sign of strength because only common shares are factored into the earnings per common share. This theory is true because given the environment; the lowest number of common shares would have the best earnings per common share Recommendation Justification:
I will justify my recommendation based on the structures considered in the analysis as follows: Bonds – 9 percent on bonds was the largest of all options with highest interest payment which helped to lower earnings before taxes. The common stock total income available after paying taxes was the lowest in all 5 five structures. This structure prevented the company from issuing bonds which normally consist of taking on additional debt. If a company is highly leveraged it becomes prone to cash flow hardships because it will have to make coupon payments regardless of its income. So, this option’s earnings per common share in years 9 to 13 is $.103, and it is the lowest of all other options analyzed. Stocks – Competition Bikes has 50 percent of preferred stock, and 50 percent in common stock which means there is no interest paid on bonds. This approach helps the company to retain all earnings before interest in taxes, and avoid interest payments on bonds. The result is highest net income and total earnings per common stock in years 9-13. Competition Bikes needs to pursue this option because earning per common share is forms the basis for comparison. 20% 9% Bonds, 80% Common Stock – Having a mixture of bonds and common stock is the preferred structure in financing because having less bonds helps a company from paying too much on bond interests. When this setup is present, the income before tax is more which helps to cushion and increase the total income available for common stock after paying the taxes. In this case, the earning per common share in years 9 through 13 is $.197 which is close to the recommended 50/50 option and preferred shares. The common stock is given as 40% 9% Bonds, and 60% Common Stock. Anytime when bonds amount is lower compared to common stock is good because the company will have to smaller amount of bonds interests. As a result the income available for common stock will be higher. Earnings per share is lower because the total shares remained in this option is higher than option 2, and the result in year 9-13 is $.181. Finally, with 60% 12% Bonds and 40% Common Stock shows a higher bonds proportion of which means that more interest is being paid out on bonds amounting to $43,200. So, dividing among 1,215,000 shares, the total income available for common stock becomes...
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