Touring Enterprises, Corporate Finance




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?
Posted Date: 3/27/2013 4:07:16 AM | Location : Pakistan







Related Discussions:- Touring Enterprises, Assignment Help, Ask Question on Touring Enterprises, Get Answer, Expert's Help, Touring Enterprises Discussions

Write discussion on Touring Enterprises
Your posts are moderated
Related Questions
Firm A has $10,000 in assets entirely financed with equity. Firm B also has $10,000 in assets, but these assets are financed by $5,000 in debt (with a 10 percent rate of interest)

Problem 1: (a) Will a corporation be morally responsible for its actions? (b) Why do corporations engage in social responsibilities, and what are the potential drawbacks?

Kodak Corporation has debt/assets ratio of .3, its cost of debt is 9% and that of equity 13%. The tax rate of Kodak is 30%. The company is not growing, has a dividend payout ratio



Top-flop division is based on the idea that the demand percentages of the 'top' and the 'flop' SKUs in a group of SKUs are fairly stable over time. For example, the 33% best-sellin

On December 31, 2009, the Real Weapons Factory reported total stockholders' equity of $447,200. On that date, total contributed capital was $360,000. During 2009, the firm had tota

I need some ideas or topic for my 8-12 pages semester assignment. Further more tools to solve the assignment. I''m working in an engineering company (in a technical role).

YOU ARE A CEO OF A SOFTWARE COMPANY WHICH HAS LIMITED ACCESS TO DEBT EQUITY MARKETS. YOUR FIRMS AVERAGE RETURN ON LAST YEAR PROJECTS IS 28% AND COST OF CAPITAL IS 12 %.Would Npv or

In this paper, we propose new forecasting methods based on advance demand information, and perform a case study to compare them to existing ones based on advance demand information