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Issue of The Common Equity

PACIFIC GROVE SPICE (PGS)

GENERAL ADVICE

You have received a fully functional workbook.

Assume it was completed by PGS’s CFO, Fletcher Hodges, with the assistance of one of his young analysts. Thus there is no need to alter anything in it. Indeed, do not hand the spreadsheet-in when you submit your exam. Upload only your action plan.

NOTES: I highly recommend that you first read, on-screen, the case and the comments I have placed in the case. Then print the case and finally print all of the tabs in the Excel workbook. Use the printed copies to take notes on as you again work through the case text and the workbook.

When making your notes, bear in mind that you are Peterson, with expertise in film studies, culinary arts and managing PGS’s operations. You are not the CFO and thus do not have to understand how any of the calculations were done by Hodges. Though it would be nice if you were able to do so, the fact of the matter is that all you need to do is develop an overarching understanding of the implications of the analysis to the decision(s) which you must make.

As such, do not spend a lot of time deconstructing this workbook and how the calculations were completed.

Instead, assume Hodges is correct in the analysis he has chosen to do. Thus, you want to concentrate on developing a holistic understanding of what each tab in the workbook is telling you about the financial operations of this firm and PGS’s options, how to assess them, how to make the optimal decision from the perspective of the owners of the business (the shareholders), and then how to explain and justify that decision to those shareholders, many of whom may be finance novices.

You may want to think of it this way: If you were explaining what the workbook means to an intelligent high school student, who knows very little about finance, what would you tell them about the problems which PGS faces and how you would use each tab to resolve those problems? What are the critical parts of the workbook which you and that student would need to know to make the optimal decision?

Focus on that information, and only that information, to write your action plan.

EXAM QUESTION

Assume you are Peterson. You know you must report your decision to the Shareholders of the firm.

You also know that PGS has the following options it may pursue:

a) Operate as forecasted on the tab F-S (Base Case).

or b) Operate as forecasted on the tab F-S (Base Case) and do one of the following:

i. Acquire the TV Opportunity. ii. Issue New Common Shares. iii. Issue New Common Shares and acquire the TV Opportunity. iv. Acquire HCS. v. Acquire HCS and the TV Opportunity. vi. Issue New Common Shares, as well as acquire HCS and the TV Opportunity.

You believe the current four-year financial projections, as well as all the other data prepared by Hodges, are reasonable, accurate, and attainable.

Given the information available to you in the workbook what is the optimal decision for the Shareholders of PGS, the one which will provide maximum Shareholder benefit?

Answer

Memo

To: Fletcher Hodges, PGS’s CFO

From: Peterson, Analyst  

Date: 03-12-2018

Subject: Project Selection for the PGS

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Recommendation 

After the consideration of 7 options available in total, the projects were selected in accordance with the priorities of the Shareholders and by considering the benefits of the shareholders, the second option should be considered. The second option involves the issue of the common equity. The issuance of common shares is an instrument to obtain long-term capital stock, representing the forms of ownership and, consequently, the payment of dividends for their acquisition is not obligatory. 

Reasons for recommendation 

The common shareholder is also known by the term "Residual owner" since, in essence, it is he who receives what remain after all the claims on the profits and assets of the company have been satisfied. The founders may lose a part of their shares if they opt for this way of raising capital. The common stock can be sold with a value or without a par value and therefore the issue of the common stock will also decrease the Equity Multiplier or Leverage from 3.4 to 2.1 as seen in the tab new common tab.

The project selection consists of evaluating several needs or opportunities to be able to decide which of them the best option is and turn it into the project that will benefit in the long run. To guarantee this, we use the project selection criteria to evaluate all the requests we receive based on the technical aspects of the study. The project here identified the ideas generating potential projects and recognizing that not all time and budget could be analyzed. The equity return or the return on equity is one of the key metrics that the shareholders pursue when they make an investment decision. In the case of the selected option that exactly happens, they are presented with two cases. The company should target the forecasted numbers or even try to exceed that for their own sake. The common share is one of the least worrisome modes of finance as the investors are ready to wait for better returns.

The founders will lose a chunk of their shares while opting for this. Their impact on the decision making will be reduced as a result of it. It will create enough capital for the firm to pursue other options in the future. One of the reasons for the selection of the option issuing common shares is that it is a futuristic measure for the betterment of the PGS. The founders will lose a chunk of their shares while opting for this. Their impact on the decision making will be reduced as a result of it. But this is better than other options because it is good for the company to have a lack of central decision making power. It is looking beyond and futuristic approach towards the development of the company.

The issue of common share will make the company be more dependable on the debt for future purposes than the equity. But considering the cost of capital, it will be a safe option for the company to opt for more debt based capital if they are hoping to raise funds in the future. By having that as an open choice the investors will enjoy decent profits over the long run as the capital method they selected will reduce the loans paid by the banks as well as their overall interest to be paid. 

Recommendation to Formalize the Business:

The next is the company here aims to achieve a good sales improvement over the year that to double-digit figures. The excel forecasts provide the industry information which will be used for further analysis. It presents an overview of the industry and how it is performing in comparing with the other industry. The industries considered will provide some light on how the performance has been and what are the important factors to be considered while the performance analysis is going on. The 4-year forecast revealed that the seasoning industry is performing well but for the firm, there is some scope for improvement. 

The option issuing common shares and the P/E ratio on such scenario is 16x in the long run as seen in the tab New common tab. This is just a forecast, but the following measure will improve the market price of the share and it will pay off the investors who seek good returns on their investment. The company should also ensure that their long-term returns for their investment are safe. Safeguarding the long-term growth of the company both regarding the sales and investor returns is keys. The investor returns are as important as the sales generation for the firm. 

The company can further improve their overall performance by opting for low liquidity as now the company reduced their total debt dependence. The company need funds only for their working capital and by opting for the common shares the company can focus on improving their fixed assets to improve the firm performance and the other key areas that need to be improved. The company can use this to generate a better return on their invested capital than just return on equity. This will be for the company and it will improve the company. 

The constant adjustment of the capital structure is strongly recommended as it may provide the firm’s timely needs. By taking care of their timely needs the firm can focus on improving their short-term performances as well. The following activities will help the firm to get investment at the very low cost of capital and it will eventually provide them with other options and the long-term benefits such as the tax benefits are a possibility under this method. 

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