Continental Carriers, Inc.
Advanced Financial Management
Continental Carriers, Inc. (CCI) should take on the long-term debt to
finance the acquisition of Midland Freight, Inc. for a few reasons.
The company is heavy on assets, the debt ratio will only grow to 0.40
with the added $50M in debt. Also, the firm will benefit from an
added $2M in a tax shield and be able to return $12.7M a year to its
stockholders and investors, instead of $8.9M if equity is raised to
finance the acquisition. Lastly, the stock price and earnings per
share will increase to $3.87 in comparison to an equity-financed
acquisition of $2.72 per share. CCI would be taking a somewhat high
risk by issuing additional stock due to the uncertainty about the
offering price. Having a low P/E ratio with respect to the rest of
the market, and the replacement cost of the firm being greater than
its book value (argument 3), there is a good chance that the current
stock price and the proposed offering prices are too low.
Although long-term debt is a better financing choice a few of the
drawbacks are pointed out. Debt holders claim profit before equity
holders, so the chance that profits may be lower than expected,
increases risk to equity may reduce or impede stock value. However,
in extreme financial situations such as a recession period, CCI would
still be able to increase its cash during a recession period with all
debt capital structure. Also, there is a remaining 12.5 million that
would have to be paid at the expiration of the bonds, but that could
be paid off by issuing new bonds or additional equity at that
time.
Five members of the board raised comments that have been addressed as
f ...