Pacific Grove Spice Company was opened in the early 1980’s as a small speciality grocer in California. Although the company was profitable & all of its net income was re-invested in the firm, retained earnings were not sufficient to fund the growth in assets necessary to support ever increasing sales for which Pacific had taken loans from large regional banks. Pacific had notched loans upto 81% of the company’s accounts receivable balance.
In the aftermath of the financial crisis of late 2008, the financing banks wanted Pacific to bring down its interest bearing debt to less than 55% which was currently hovering around 62% & its equity multiplier to 2.7 times from the current 3.47 times. The bank had given a deadline of June 30, 2012 to achieve the above.
Pacific had the following options to be able to deliver on the bank’s wishlist :
1. Accept an offer from a cable cooking network to produce & sponsor a new program which would increase Pacific’s sales, profit & cash flow but would require investment in assets & working capital.
2. Raise new equity capital by selling common stocks which would come with a premium because of higher transaction cost leading to a net earning of $ 27.50/- against the market value of $32.60.
3. Acquire High Country Seasonings with a sales revenue of approximately 22% of Pacific.
Capital budgeting analysis of the cable TV network opportunity has shown that against an investment of $ 144000000, there is an IRR of 41.28%. If one looks at the NPV, one sees that the NPV is also positive at three different option percentages. There is also an increase in the income which increases YoY.
If one looks at the table ( Comb_Income ) of the situation with a combination of High Country Seasonings and the TV programme, we can see some major advantages. Looking at the ratios of EBIT/Net Sales and Net Income/Net Sales, we can see a good growth YoY. Further by 2012, the EBIT/Net Sales has risen to a healthy 6% (as against a...