• Demonstrate a deep understanding of the theory and practices of financing a firm and its capital structure.
• Evaluate the financing risk that may result from the chosen debt ratio.
Case Promaut Corporation
Promaut is an engineering company which was founded 30 years ago by the current President, Mr. Joan Matutano.
The company showed profits for most of the years, but on the year 2015 the company tried to scale up with debt heavily increasing their operations in the export markets. The situation had a negative development due to wrong strategic approach and a lack of control of the company managers. As a result from this experience and after a very slow recovery, Mr. Matutano is now much more risk averse, and therefore he is trying to avoid debt as much as possible. Actually the company has a 0 debt.
Mr Matutano has now a new project, this is a new venture with the self-drive cars industry, and he believes this could be a very profitable business. The required investment for this project is of 70M€, and the expectations for profitability show annual pretax earnings of 10M€ in perpetuity.
Now the company, or Mr Matutano, has to decide whether to finance with debt or equity. Even though we dislike debt, he hired lately a very well known CFO who believes that debt would be adding value to shareholders. According to the first estimates based on Peter Franciscus research (Peter is the “new” CFO), the best deal they could find is a 50% debt investment, this means that the company should rise half of the investment in new chares and 50% with Bonds. An increased level of debt would make the company more vulnerable and therefore the financing costs would sharply increase up to an undesirable level.
The bonds would be issued at par value with 6% annual coupon payments.
Promaut is a Spanish company, and the income tax rate is 25% at the present moment.
The company has a market capitalization of 350M€, and 7M shares outstanding.
The company cost of equity is 10%.
Mr. Matutano is not only very risk averse, he is a man who does not trust anybody, and feels very stressed buy this situation, his wife has adviced him to talk to you, as even though you are still studying, she feels you are a brilliant student, and she fully trust you, so Mr. Matutano has asked you for advice. If he is satisfied with the advice, you will have a good opportunity to find your first paid job after you finish your studies.
1.-The first thing he wants to know is, if he should issue debt or equity for this investment and why.
2.- As Promaut is a public company, he would like to know which is the market value balance sheet before the investment in the new project is announced.
3.- If Promaut decides to make the investment 100% with Equity, as Mr. Matutano prefers, what would be the Net Present Value of the project?
4.- What would be the market value balance sheet after the company announces the project fully financed by Equity? How many shares will have to be issued in order to finance the project? And what would be the price per share?
5.- Construct the market value balance sheet after equity issue and before announcing the new investment project. How many chares outstanding has the company? and how much is the price per share?
6.- Construct the market value Balance Sheet after the new investment has been done.
7.-What will be the market value of the company if the finally decide to issue debt?
8.- Prepare a balance sheet at market value after the debt is issued and the investment is done, what will be now the value per share?
9.- Which of the alternative do you think would be better for Mr. Matutano, as he is the majority shareholder?