For Case III, below is the right answer, please revise ours accordingly. 1. It appears the decision to acquire the equipment and perform the image upgrade has already been made. As such, we can assum
Running Head: THOMPKINS AUTO GROUP 0
Thompkins Auto Group
Recommendations for financial options
Competent capital guidelines rely on pecking theory which states that in choosing financing options, the given order is followed ; internal financing- debt- equity. Internal financing involves the use of the company’s own profits and capital source for new investment instead of having to distribute them to owners of firms and other external investors. Debt is when a fixed sum is borrowed from a lender, then payed later at the agreed time, with interest. Equity involves the sale of a percentage of business to an investor for capital.
The Thompkins auto group currently relying on its 2 strategies may end up collapsing, therefore opting for means to invest in the group. The group analyzing the situation realizes an estimate of 2million dollars for the investment. Half of it going to building improvements and the remaining half to equipment required. The expenditure to improve the businesses image is generally high, since the company makes about 1.5million dollars annually. The future success of the Thompkins auto group entirely relies on the decision the owners will make concerning the most effective financial plan. Basically 3 options have been suggested. That is; borrow the whole amount (2 million dollars) from a financial institution, issue new shares of the company and financing through sale of dealership subprime notes receivable.
For this particular company, on weighing the three options, the pecking theory might not apply. The most suitable financial option for the Thompkins group to take is the one of acquiring a secured bank loan (debt). This is the least negative choice. The secured loan pledges dealerships 3million dollars, for a span of 5 years, with a 4% interest. Taking a loan will add on a previous loan, the tax rates will be moderately high (35%) but on the positive side, this option allows the company to achieve the intended goal, assuming through the improvements, the group will record increase in profits and cash flow will definately increase providing funds to pay the loan in time and as well paying the previous loan they had: Generally, loans usually have the cheapest interest rates. These rates paid, tend to be cheaper than other interest loans like venture capital which are high.
The unsecured loan is ruled out because typically, the rates of interest are higher for unsecured loans. This is because there's higher risk level for the lender, of the loan not being paid back. Hence measures enforced. Increasing costs for the business at this point lowers the developing graph of the company). Unsecured loans are difficult to obtain especially if the borrower has not had much positive history in credit or don't have a regular capital from the business. When you receive a loan, you are provided with a some rules dictating and guiding how you spend the money hence spending the money where you see fit, (purchasing new equipment, entering new market, or doing a new marketing plan). The company also doesn't have to give up equity to get a loan as long as it gives a pledge to make payment on time.
It won’t be advisable to opt for selling shares since the stockholders of the group don’t hold much and if they sell their shares, the rates will be minimal since the economy of the town is at a drop, this will not be suitable for short term hence the Thompkins group will not in it's normal and usual manner boost the economy of North Central Texas. In addition to this, for the shares sold, the owners will demand approximately 15% dividends hence minimal profits and depressed returns.Generally, dividends act as sources of cash flow to the investors , they reflect almost clearly, the company's value. It should be noted at all times that stocks with dividends have less chances to reach unsustainable values. It is known to investors that dividends put a ceiling on declines in market.
Also, the investors have no power over the dividends and this also imposes more tax risks. On the brighter side this option automatically does away with the loan. The major variables to consider include interest rates being paid on student loans and the returns on investments as expected. Basically, it is only reasonable to makes sales on stocks so that debts get paid if the cost on debt is greater than the returns that the investments will generate but it is not applicable in this case.
Selling of dealership subprime notes receivable, charging 18% on interest, the company will be able to remove debts, receive 85% of face value, only suitable in the long term. This option yields interest loss and outflow, hence not the most suitable. Adjustable rate loans should get a consideration, when it comes to subprime lending because make this kind of payments may rapidly shoot if the interest rates increase. It thus means that the future will get riskier.
To estimate costs of capital;
1.Aggregate capital = Aggregate of debt outstanding plus total Preference share plus Market value of common equity. ...
2. Weight of Preference Share = preference share/ aggregate capital.
3. Preference share cost = Dividend on preference share/ aggregate of Preferred Stock.
For every single debt issued, the firm is able to notice its increase in borrowing expenses as illustrated by the coupon rates that it will make to the investors for them to help in paying the debt. The costs of capital are key to both the business and the investors because it will help them evaluate all the available investing opportunities. This is possible because the future cash flows are converted into the present values using a discounting rate. The costs of capital are also key to the company in budgeting its capital given the various sources of capital; bringing us back to the borrowing, which is clearly the most advantagious compared to the other plans for the company.
Therefore, Thompkins group is encouraged to take a secured loan, because they can secure huge amounts of loans since lenders have great confidence that their cash will get back via loan pays or through selling the properties given as securities, basically, the attract lower interest rates as compared to loans that are unsecured because the financial risk experienced by the lender is reduced.
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