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APA
Subject:
Mathematics & Economics
Type:
Case Study
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English (U.S.)
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Presentation
Case Study Instructions:
Merit Enterprise Corp.
Sara Lehn, chief financial officer of Merit Enterprise Corp., was reviewing her
presentation one last time before her upcoming meeting with the board of directors.
Merit's business had been brisk for the last two years, and the company's CEO
was pushing for a dramatic expansion of Merit's production capacity. Executing the
CEO's plans would require $4 billion in capital in addition to $2 billion in excess
cash that the firm had built up. Sara's immediate task was to brief the board on
options for raising the needed $4 billion.
Unlike most companies its size, Merit had maintained its status as a private
company, financing its growth by reinvesting profits and, when necessary, borrowing
from banks. Whether Merit could follow that same strategy to raise the $4 billion
necessary to expand at the pace envisioned by the firm's CEO was uncertain, though
it seemed unlikely to Sara. She had identified two options for the board to consider:
Option 1: Merit could approach JPMorgan Chase, a bank that had served Merit
well for many years with seasonal credit lines as well as medium-term loans. Lehn
believed that JPMorgan was unlikely to make a $4 billion loan to Merit on its own,
but it could probably gather a group of banks together to make a loan of this magnitude.
However, the banks would undoubtedly demand that Merit limit further borrowing
and provide JPMorgan with periodic financial disclosures so that they could
monitor Merit's financial condition as it expanded its operations.
Option 2: Merit could convert to public ownership, issuing stock to the public
in the primary market. With Merit's excellent financial performance in recent years,
Sara thought that its stock could command a high price in the market and that many
investors would want to participate in any stock offering that Merit conducted.
Becoming a public company would also allow Merit, for the first time, to offer
employees compensation in the form of stock or stock options, thereby creating
stronger incentives for employees to help the firm succeed. On the other hand, Sara
knew that public companies faced extensive disclosure requirements and other regulations
that Merit had never had to confront as a private firm. Furthermore, with
stock trading in the secondary market, who knew what kind of individuals or institutions
might wind up holding a large chunk of Merit stock?
TO DO
a. Discuss the pros and cons of option 1, and prioritize your thoughts. What are the
most positive aspects of this option, and what are the biggest drawbacks?
b. Do the same for option 2.
c. Which option do you think Sara should recommend to the board and why?
Case Study Sample Content Preview:
MATHEMATICS AND ECONOMICS
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MATHEMATICS AND ECONOMICS
Question 1 Answer
In order to expand a business, it is necessary for the owners to source for financial resources. Therefore the available resources that can be tapped are divided into two; acquisition of debt and obtaining equity finance. Debt financing will involve obtaining a loan which is repaid plus an interest while equity financing may involve selling a firm`s interests like floating of shares. If Merit decides to use JPMorgan Chase bank to borrow the $4billion in loan and an additional $2 billion, there are advantages and disadvantages accrued to it. The most positive aspect in debt financing is that, it does not temper with the ownership interests of the firm. Merit can remain private and independent. Besides, JPMorgan Chase bank will have no entitlement to future profits of the firm. The bank will only be entitled to repayment of the agreed -upon principal and interest of the loan. Moreover, the principal and interest obligation are normally constant, hence can be planned for except in an incidence where a variable rate has been used. There are no complications in obtaining debt financing since Merit is not expected to conform to various legal regulations or requirement. Merit will also not be required to send mails to a big number of investors and hold regular meetings in order to make certain decisions. Furthermore, Merit can use its tax returns to pay the interests hence reducing the cost of the debt.
However, the major drawback of this option is that debts must be repaid at some point. The numerous installments in interest paid may be too much for Merit; to an extent if it defaults there are grave repercussions which might render the firm bankrupt. Acquiring such a huge debt of $4billion and an additional $2billion of which it w...
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