Corporate Finance: Case and Questions
BUSINESS ORGANIZATIONS
Andrew Gates and Larry Page just graduated from UC with a master’s degree in Information Technology. They want to set up their own server building company to help make networking of businesses run smoothly in their municipality. The servers will play a key role in telephony, internet and intranet connections in corporate organizations and other institutions in the Hilton area. They know from independent investment research that IT businesses are striving and very profitable in the State of South Carolina where they want to locate the business. Andrew and Larry know that before they can invest their time and other resources in the project, they must obtain financing, which means that they must raise money to pay for the investment cost and other operating expenses. Because the company might not be listed in any capital market right away, they might not be able to raise equity funding publicly. Therefore, they are considering raising long term capital from various sources including angel investors, venture capital market, bank/finance companies’ long-term loans, crowdfunding, and initial public offerings (IPOs). They learnt in corporate finance course they took two years ago the advantages and disadvantages of different forms of business organizations (mainly sole proprietorship, partnership, limited liability, and corporation). They are worried about the legal concept of limited liability and how it will affect their personal fortunes in the future in case the business fails. They are not very sure which form of business organization to set up to protect their personal liability and access huge funding. Therefore, they are considering a partnership, a limited liability, or a corporation. A cash budget they prepared shows that $5 million seed money would be needed to hire programmers, buy computers, rent an office space, promote and market the business as well as to meet other business development expenditures. They have agreed to share profits and losses equally if they decide to form a limited partnership. The general partner will, however, be paid a fixed salary of $5,000 per month before taxes and other payroll deductions.
In order to make good and right decision, Andrew and Larry have approached you to help them understand the advantages and disadvantages of the various forms of business organizations and possible sources of funding for the business.
- Give 2 advantages and 2 disadvantages of each of the following forms of business organization to Andrew and Larry:
-
- partnership,
- limited liability, and
- corporation
- Ultimately, what form of business organization would you recommend Andrew and Larry to consider. Why?
- Based on your recommendation above, explain to Andrew and Larry if the following sources of raising long-term capital are appropriate for them:
-
- angel investors (angels)
- crowdfunding
- venture capital
- initial public offering, and
- long-term debt
2. FINANCIAL STATEMENT ANALYSIS AND FINANCIAL MODELS
Andrew and Larry want to use financial planning models to prepare a projected (or pro forma) financial statement to determine the profitability and financial health of the business for the next year. Use the proforma financial statement below to answer the following questions:
| PRO FORMA INCOME STATEMENT | ($millions) |
| Total operating revenues | 78 |
| Less Expenses | 57 |
| Less Depreciation | 9 |
| Earnings before interest and taxes | 12 |
| Less Interest | 2 |
| Net income before taxes | 10 |
| Less taxes @ 10% | 1 |
| Net income | 9 |
| PRO FORMA BALANCE SHEET | |
| Assets: | |
| Cash | 9 |
| Other current assets | 18 |
| Net Fixed Assets | 40 |
| Total Assets | 67 |
| Liabilities and Equities: | |
| Accounts payable | 12 |
| long-term debt | 18 |
| Stockholders’ Equity | 37 |
| Total Liabilities & Equities | 67 |
a. What is the estimated profit of the business for next year?
b. Calculate the following profitability ratios and explain to Andrew and Larry whether the business looks profitable:
i. Profit margin
ii. Return on Assets
iii. Return on Equity
Also explain and calculate the:
iv. Operating cash flow
c. Assuming you project a 25% increase in operating revenue (sales) per year what will be the anticipated operating revenue in two years?
d. If net income is projected to increase by 10% per year, what will be the profit margin in next two years?
e. What will be the estimated earnings per share (EPS) next year if 1,000,000 shares are issued? (note: EPS = net income / total shares outstanding).
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Answer each of the above questions with proper details.
