Granite Apparel- Source of Funding

Presented to Mr. Kurt Sullivan Subject Source of supporting From JMSB consultants Despina Papadopoulos Angela Christopoulos Mathieu Apuzzo AJ Kenth Date March 2007 Main Issues * Choosing the appropriate source of financing, between Initial unexclusive offering, long bourn debt or preferred sh bes, to raise funds for the expansion of Granite habit. Recommendations * Granite Apparel should use an Initial Public whirl as a source for raising funds. Analysis Quantitative Initial Public Offering The appeal of matter common make dos for your guild was found by adding the undermentioned expenses (APPENDIX ONE)Bridge Financing Rate ( familyly) 10. 25% Amount of Bridge Financing 50,000,000 Period 6 months Yearly Interest Cost 2,562,500 Lump tally Issuance Fee 4,000,000 Total Issuance Costs 6,562,500 To issue common shares is really expensive to cross and at that place are also other related be for a connection going commonplace. These termss finish be * More experienced acc ountants for financial statements issuance and high internal compliance * Auditing fees * Dividends untold of the factors are above are very difficult to quantify, but using assumptions we could begin an idea of the greet over a 5 year basis to compare with preferred shares.First, lets buzz off a dividend re introduce, hoping the beau monde does well and we pay out a 20% dividend treasure with a reaping of 25% in sales from 2007 2012. We get a total dividend amount to be 18. 82 one thousand thousand (APPENDIX ONE). Since dividends are not an obligation but they are a benefit for shareholder satisfaction, we have a range over a 5 year period of costs between 11. 5 one thousand thousand and 30. 4 zillion. These values take into consideration m whatever assumptions (g= 8%, b = 0. 80 and ROE= 10. 55%) Total 5 year dividend 18. 82 million Audit fee (1M per year assumption) 5 million Fees/ Bridge Financing 6. 56 million Total 30. 80 million Range 11. 5 30. 4 million Another fa ctor to consider for an IPO is the decrease in control for Taylor and the current shareholders. sooner IPO After IPO Total Shares 20,000,000 26,000,000 Taylor Ownership 12,000,000 12,000,000 Percentage Ownership 60% 46. 15% If Mr. Taylor is at ease losing total control of his attach to with 46. 15% resulting power (where control is 50%), the IPO bath be a very attractive solution. If Mr. Taylor decides to keep full control of his political party, he can either bribe himself more shares or the company could issue deuce types of common shares Non- pick out and voting.Taylor Ownership 12,000,000 Percentage Ownership 50% Total Voting Shares 24,000,000 Total Non Voting Shares 2,000,000 Preferred Shares As seen in APPENDIX THREE, the total cost of issuing preferred shares would be $30,200,000 over 5 years. Raised pileus 50,000,000 Dividend Yield 9% Annual Dividend (9% * 50,000,000) 4,500,000 buy Premium 10% Face Value 55,000,000 Issuance Fees 2,700,000 5 year Dividends (4. 5M x 5) 22,500,000 Repurchase Premium 5,000,000 Total Cost 30,200,000 big-Term Debt Long-term debt is the second source of financing the company has the woof of adopting.Metropolitan life approached Granite Apparel and was prepared to lend them 50 Million dollars at a fixed rate 2% higher than the long-term U. S treasury yield. The term of the loan was 10 years. Exhibit 6 illustrates the U. S treasury yields. Since the loan has a 10 year term, we decided to select the 10 year Risk Free rate, which is 4. 56%. In total the please rate of the loan would amount to 6. 56%. In order to decide, which alternative is best suitable for the company, we moldiness occur the cost associated with borrowing. In addition, we must also add the upfront fee of 1,800,000.The upfront fee is calculated by multiplying 200,000 common shares and the behave price of 9$. We assumed that the value of the profligate was equal to 180,000,000 in order to use the 9$ stock price. We also assumed that the loan t ake onances would be done monthly, which gave us a monthly salary of 569,267. 46$. Appendix 2 is a loan amortization schedule and indicates the amount of hobby and great is included in each payment. The sum of all interest payments is equal to 18,312,099. If we take the total interest cost and the upfront fee the total cost of the loan would equal to 20,112,099.However it is also Copernican to respect that interest is tax deductible. The loan amortization schedule enabled us to witness the PV of the tax shield of 79,712. 24$. In conclusion, the total cost of the debt option is equal to 20,032,386. 75$ We also wanted to note that nonrecreational 10% principal per year for 10 years on the loan is impossible. According to loan amortization schedule, the 10% yearly principal payment would start from year 6. For the first 5 years, most of the payment is attributed to interest, which decreases the principal portion of the payment.Performance and Ratios An important factor in decidi ng on which way to finance product is how it affects your financial statements. Since these tools will be the primary source for investors it is important have them appear strong (APPENDIX FOUR). If the company chooses an IPO, the following ratios would occur in the 2007 financial statements of Granite Apparel. Ratio Industry Granite Apparel Debt/Capital 15. 1% 31. 0% TIE 41. 2 57. 75 PE 22 12 ROE 18. 4% 14. 16% With an IPO the companys financial statements would look very strong.Its debt is already higher than the industry average and therefore issuing common shares would decrease the risk of the company. Both the Debt/Capital and TIE ratios express that strength. If the company chooses to issue debt, the following ratios would occur in the 2007 financial statements of Granite Apparel. Ratio Industry Granite Debt/Capital 15. 1 61. 52 TIE 41. 2 6. 47 ROE 18. 4 21. 94 The risk of the company by issuing more debt would be extremely high and way above the industry averages. By demons trating both(prenominal) Debt/Capital and TIE, we could see a large increase in the companys risk which is not in the companys favor.They might be reevaluated as a riskier company and therefore would no longer be able to purchase at low interest. The ROE plays in favor, even so, because the total Equity is divided among fewer shareholders. It looks good for investors but not for creditors. If the company chooses to issue preferred shares, the financial statements would look very similar to issuing an IPO. This occurs because the preferred shares would be keep backed in the Equity section of the financial statements due to their self-control qualities. QualitativeGranite Apparel is faced with iii financing mediums initial public offering, long term debt or preferred shares. In the decision process, it is important to weigh the benefits and shortcomings of each financing option. Initial Public Offering (IPO) Benefits * Increase in Shareholder Capital * Increased wealth without di viding authority amongst partners * No dividend obligation on common shares. * Inexpensive method of financing. * subject to maintain control of the company as long as shareholders have less than 20% ownership Drawbacks Granite would need to undergo a thorough assessment of its operations, financial records and legal situation by both Continental Securities and the securities commission. * Three to six month due diligence process. * Minimum requirements in accordance to US GAAP system is very expensive to implement * Decisions based on stock price The public trading of the shares establishes a value for the company and sets a benchmark. This works in favor of the company as it is helpful in case the company is looking for an acquisition or conflater. It also provides the share holders of the company with the present value of the shares.Furthermore, once the shares are traded, they carry a food market value that is different from the book value depending on demand (volume traded) this can provide Granite with the incentive of offering stock options to employees as an added honorarium. Additionally, the investors that are in the company have liquidity on their share of the company, however, if an investor should decide to carry through his portion the company is not undefiledly affected because the sale is completed on the market. When a company issues common shares, there is no obligation to pay dividends.This can be an immense advantage for Granite as the company is in a growth phase and dividends can be limited in order to compete in an industry with larger players. In turn, this also allows Granite to keep the cost low for the future. In addition, the firm will not go bankrupt if is not able to pay out dividends. More than frequently, managements decisions may be effected by the market price of the shares and the feeling that they must get market recognition for the companys stock. Often, this can lead to bad decisions and consequently a decline in st ock price.As the share price of Granite falls, may lose market confidence, decreased valuation of the company may affect lines of credits, subaltern offering pricing, the companys ability to maintain employees, and the personal wealth of insiders and investors. Not to mention if Granite decides to issue most of its shares to the public it may be a target for a hostile takeover, evidently a loss of insider control. Long term Debt Using long term debt will allow granite apparel to immediately acquire the funds, however it will place both financial and operational standard covenants in effect. Operational Prohibited to scale annual large(p) budget * Not allowed to acquire without authorization * Cannot change current executive compensation or dividends Financial * Limited to a borrowing to equity ratio of 1. 20 * No orifice to raise short or long term debt without authorization Using long term debt for Granite is very risky if the economy suffers and sales are down. Granite will st ill have to pay the interest on the principle loan without having the flexibility of getting another loan. When the interest payments are not distributed to debt holders, the firm may go bankrupt.As stated, If earnings decrease it might be very risky to carry over 3. 57 million dollars in interest expense as an annual obligation. Moreover, in the event that Granite is presented with the opportunity to merge or outright acquire a competitor, the decision will have to pass through Metropolitan. This can lead to further complications and loss of decision making control for the management of Granite. Preferred Shares Although this method is cost effective, it can also confiscate the ability for management to take important decisions without citation from shareholders. Granite can redeem the shares at a ten percent premium only after five years * Shareholders have no voting right, but receive priority over dividends * Can be given voting rights if Granite does not pay for two unbent y ears Similar to long term debt, preferred shares present the drawback for authorisation loss of control. For instance if there is an economic downturn and Granite is unable to issue payments for two consecutive years to its preferred shareholders, they are granted full voting rights and can potentially control the entire company.Preferred shares can either be placed in the equity or liability section of the equilibrate sheet. In this particular scenario, the preferred shares would be in the equity section because they show evidence of ownership. For instance, if dividends are not paid for two years consecutive, they can exercise their voting rights and consequently allow them to decide on major business developments. Given the three financing methods, Granite would receive the necessary capital in time to fulfill their marketing needs.Given the economic state preferred shares are risky when considering the potential loss of control to the shareholders. Similarly, long term debt ca ries the interest risk burden without possibility of acquiring a new loan. Conversely, initial public offering allows the flexibility to wear capital at any point with the exchange of ownership and still allows the decisions to be made by the board of directors. Although the net income on the expansion is not quantifiable, by the issuance of IPO, Granite remains protected from third party influence and control, interest burden and loss of decision control. Plan of Action Announce the plan to the board of directors and wait for quorum approval or issuing an IPO * If Mr. Taylor and other board members are expressing worries about dilution of ownership, consider issuing two classes of shares non-voting and voting. * Contact the investment firm to find out potential differences for issuing two classes of shares * Hire and find experienced accountants to prepare the financial statements in accordance to US GAAP for public companies since the company will go public * Select an investment bank with a good reputation and expertise to advice and practice underwriting functions. Organize internally for high compliance in accordance to the securities commission Contact and find a reputable auditing firm (KPM, Deloitte, Price Waterhouse or Ernst Young) * File with the Securities and Exchange Commission. * Once the request has been processed Granite Apparel should request its IPO on the stock exchange with firm commitment. * Once capital is certain (under firm commitment) and as quickly as possible, search for store locations.These locations should be prime, and in an area where Granite * Apparel can compete strongly with the major players. Time is important, since competitors are catching up to Granites innovative products. The company must enter quickly and efficiently into the market. * Prepare for manufacturing increase to supply new stores. * The company should find new innovative products to keep it a step ahead from the competition and become first movers to gain customer loyalty.