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Continental Carriers, Inc.

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Introduction

Continental Carriers, Inc. Advanced Financial Management Professor Clayton June 16, 2005 Tim Boyd Dave Chen Ian Hoffman Chirayu Patel 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. ...read more.

Middle

In addition, by buying back bonds annually, the interest expense is further decreased, thus creating less of a burden on the cash flow. In contrast, an equity-financed acquisition would spread the net income out over 3 million more shares, thereby reducing the dividend pay-out to shareholders. 2. Another director argued that with equity financing, the shareholders will yield a 10% EBIT of $5M. Furthermore, this director posited that 3 million shares at $1.50 in dividends would only yield $4.5 million dollars in a cash outflow, thereby increasing the company's equity by the difference each year. This argument does not account for the $2M tax shelter that is gain in the debt financing. The expected pay-out per share when using debt financing would be $1.7 per share compared to $1.2 per share of equity financing. The total dividend pay out is also 1.3 M less for debt financing. Since 71% of the assets are fixed assets, Debt ratio of .4 and current ratio of 1.34 does not seem to be a bad number. ...read more.

Conclusion

5. The last director argued for a preferred stock in lieu of a bond issue. This alternative would yield a preferred stock pay-out of $5.25M. The bond alternative would yield a total stockholder pay-out of $7.04M. Furthermore, an equity financed project will likely lower the overall stock price, which would offset the benefits of a preferred stock with a dividend of $10.50. Preferred stock issuance is not good for existing board members and especially common stock holders. It provides a fixed dividend pay out of 5.25 M to the preferred stock holder and leaves the common stock holder with only 3.7 M, which equals a dividend level of only $.83 per share. The common stock holder would be left with only $.22 per share if EBIT grew to only 23.7M. Given that CCI is currently light on debt, the tax-shield resulting from debt, and that a greater return would be realized by stockholders under the issue new debt alternative, it is recommended that CGI pursue their opportunity to sell 50 million in bonds to the California insurance company. Continental Carriers, Inc. 3 June 16, 2005 ...read more.

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