Analyze the pros and the cons of the different methods of financing a capital im
ID: 2731234 • Letter: A
Question
Analyze the pros and the cons of the different methods of financing a capital improvement project. Include both qualitative and quantitative considerations. Calculate the net costs associated with financing the project with retained earnings of $2.44 Billion (assuming the firm consistently earns 4% on retained earnings), long-term note payable for 5 years at 4.5% interest rate), or issuing new shares of preferred stock carrying a dividend of 5%. Here is additional info on the balance sheet...
Period Ending Jan 30, 2016 Jan 31, 2015 Feb 1, 2014 Assets Current Assets Cash And Cash Equivalents 1,370,000 1,515,000 1,510,000 Short Term Investments - - - Net Receivables - - - Inventory 1,873,000 1,889,000 1,928,000 Other Current Assets 742,000 913,000 992,000 Total Current Assets 3,985,000 4,317,000 4,430,000 Long Term Investments - - - Property Plant and Equipment 2,850,000 2,773,000 2,758,000 Goodwill - - - Intangible Assets - - - Accumulated Amortization - - - Other Assets 638,000 600,000 661,000 Deferred Long Term Asset Charges - - - Total Assets 7,473,000 7,690,000 7,849,000 Liabilities Current Liabilities Accounts Payable 2,114,000 2,213,000 2,420,000 Short/Current Long Term Debt 421,000 21,000 25,000 Other Current Liabilities - - - Total Current Liabilities 2,535,000 2,234,000 2,445,000 Long Term Debt 1,310,000 1,332,000 1,369,000 Other Liabilities 1,083,000 1,141,000 973,000 Deferred Long Term Liability Charges - - - Minority Interest - - - Negative Goodwill - - - Total Liabilities 4,928,000 4,707,000 4,787,000 Stockholders' Equity Misc Stocks Options Warrants - - - Redeemable Preferred Stock - - - Preferred Stock - - - Common Stock 20,000 21,000 55,000 Retained Earnings 2,440,000 2,797,000 14,218,000 Treasury Stock - - (14,245,000) Capital Surplus - - 2,899,000 Other Stockholder Equity 85,000 165,000 135,000 Total Stockholder Equity 2,545,000 2,983,000 3,062,000 Net Tangible Assets 2,545,000 2,983,000 3,062,000
Explanation / Answer
Pros
Funding your growth through retained earnings can be a powerful strategy for some businesses. It doesn't add to your debt profile or sap your profits with interest payments. This conservative option also allows you to maintain full control of your business rather than complicating the picture with creditors, new partners or outside investors. Involving outsiders in your company, whether as partners, lenders or angel investors, gives them a degree of influence in how you run things. Funding growth internally through retained earnings keeps you firmly in the driver's seat.
Cons
However, funding expansion from retained earnings also has disadvantages. For one thing, it's slow. You run the risk of missing business opportunities while you build up the necessary funds. Your business also needs cash to fund ongoing operations. If you devote too many of your resources to growth, you may be starving your company of the cash it needs to be healthy right now. Although outside investment means giving up a degree of control, you might gain from the experience and insight of these new players in your business.