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DEBT POLICY

Continen tal

Carriers, Inc.

I.

Introduction

Continental Carriers Inc is a trucking company which focuses in carrying general commodities. From the start of its operation in 1952, the company manages within the district of the Pacific Coast and from Chicago to various places in Texas. They attained few short term loans resulting from a low debt policy and evading long term debt. The

company obtained its profitability and internal growth from the time that Mr. John Evans was appointed as President of the company. He focused on rigorous marketing and high-tech operations. Because of this, the company became known in the trucking industry as a widely profitable key performer because of its unremitting revenues and declining operating costs.

Because of the presidents eagerness to preserve and develop the companys profitability, he supported the acquisition of Midland Freight, a common carrier serving Michigan and Indiana from Chicago expecting that it would expand CCIs route system and appeared well suited for the type of marketing and cost-reduction programs that had cultivated CCIs growth. He believed that in order to carry out this goal and objective, there should be an external financing of $50 million.

This study provides a comprehensive insight to the company. The hallmark of the report is the detailed strategic analysis and the right decision that the company should put into action in order to expand its revenue and decrease its operating costs through external financing. It also aims to build analysis, solutions and recommendation on how it will attain its goals and objectives.

II. Executive Summary

III. Highlights

IV. Company History

V. Point of View

JOHN EVANS President of Continental Carrier, Inc.

VI. Time Context 1982-1997

VII.

Statement of the Problem

Which among the three options should CCI choose in order to attain its

goal?

A) selling $50 million in bonds at a 10% interest rate to a California Insurance Company and with maturity of 15 years; B) issuing 3 million in common stocks at $17.75 per share with a dividend rate of $1.50 per share; C) issuing 500 000 preference shares at a par of $100 per share and with a dividend rate of $10.50 per share

What are the advantages and disadvantages of the several alternative methods of financing CCIs acquisition of Midland Freight, Inc.?

VIII.

Objectives To determine the best financing source that will maximize the wealth of the companys owners.
To study the advantages and disadvantages of the acquisition of Midland

Freight Inc.

IX. Areas of Consideration

INTERNAL / EXTERNAL ANALYSIS

Strengths: A successful performer financially market confidence in its capability for continued revenue growth

Acquisitive/growth oriented Low operating cost The company currently does not pay any interest expense because it does not use any long-term debt.

Rated as an attractive by above average return performance

Weaknesses policy of avoiding long term debt

X. Alternative Strategies

Presented below are the options available for the company:

BOND/DEBT FINANCING

Advantages:

1. Less amount of taxes 2. Has a positive DFL which means that a change in the level of EBIT will

positively affect the EPS


3. High debt ratio resulting from the firms degree of indebtedness and

high financial leverage.


4. Least cost of financing. 5. Higher EPS than stock. 6. Higher potential return. 7. Using debt to raise funds will be viewed positively by existing

shareholders, as they will fully capture the total increased value of their stocks.
8. No payment of dividends

Disadvantages:
1. Greater level of financial risk.

2. Payment of interest.

PREFFERED STOCK FINANCING

Advantages:
1. Outflows only consist of dividend payments.

2. No principal has to be repaid in the future. 3. No payment of interest.

Disadvantages: 1. High cost of issuance


2. The option for issuing preferred stock will bring about no additional benefit

to the company as the market value of the firm will remain the same whether additional common stock or preferred stock are issued. 3. Higher amount of taxes.

COMMON STOCK FINANCING

Advantages: 1. No principal has to be repaid in the future. 2. No payment of interest

Disadvantages:
1. Uncertainty of the offering price for new common stock provide reasons

for raising the required funds through debt or stock price has been very variable 2. High cost of issuance 3. Higher amount of taxes. In this case, the company is extremely facing a problem on choosing which of the options given will be the most beneficial. Here are some of the steps that

the company should consider in order to end up to its desired goals and objectives.
1. Through getting the income and dividend data for 1988, before the effects of

the acquisition can be reflected, the current operating and financial position of the Continental Carriers, Inc. must first be evaluated.

2. Consider the effects (positive or negative) of the acquisition on earnings

before interest and taxes, interest expense, tax expense, dividends and key financial indicators such as the degree of financial leverage, the debt ratio, earnings per share, and the resulting effective interest rate under each of the alternatives. This will help the company to overview which alternative will contribute the most remuneration with the assessment and comparison to the current situation and to other alternatives. 3. It will be advisable for the company to graphically
4. For each financing plan, it would be functional for the company to graphically

characterize the correlation between the EPS and EBIT.


5. All cash inflows and outflows for the 15 years should be verified with each

alternative form of financing this will result to exposure to the achievability of pursuing any one strategy, showing the companys expected revenues and costs. (Only disparity costs and revenues tied to each approach should be used in the study). 6. All qualitative factors should be taken into consideration which has greater effects in the decision such as company policy and market performance.
Maximization of wealth of existing stockholders, utilization of future earnings and diminution of risk should be the basis on the companys preference of financing

XI. Recommendation With regard to the evaluation and analysis that we have made, we offer to carry out the acquisition of long term debt through selling of $50 million worth of bonds to a California Insurance Company. The best advantage of this option is its lower cost of
financing as compared to the issuance of stock which is the main goal of the Continental Carriers, Inc. Another thing is, even though the use of bonds will not increase after-tax

earnings, it is still preferable because the bond issue results in interest expenses which are tax-deductible. There is also a sinking fund which through this, the company will have more than enough left to pay its common stock shareholder resulting to the uninterrupted betterment of the market perception of the companys stock.

And also, through this option, Continental Carriers, Inc can grab the opportunity of having a high EBIT which is justified by a high Degree of Financial Leverage.

XII.

Plan of Action Continental Carriers, Inc can achieve its goals and objectives if it will choose the

most effective and advantageous option. The decision of the president of the acquisition of additional business activities or companies at the same level of the value chain (which also have strong and firm financial status) is helpful since it will lessen the pressure of severe competition. In order to To issue $50 million in bonds, CCI must first approach a California insurance company to set the contract. In this indenture, terms of payments must be defined, including the 10% interest rate applied on these bonds with a 15-year maturity, and the requirement of an annual sinking fund of $2.5 million. After the bonds have been issued, the funds acquired will be used for CCIs acquisition of Midland freight, Inc. The terms of the merger must be settled after the acquisition. The expansion of the route system and implementation of marketing and cost reduction programs must also be decided upon. Throughout the duration of the bond financing plan, CCI must strictly adhere to the terms of payments of the bond issue. It must meet its interest payments, and comply with the annual sinking fund of $2.5 million and the $12.5 million payment at maturity. The existing shareholders of CCI must be satisfied through the declaration and payment of annual dividends at $1.50 per share from the companys retained earnings. Finally, CCI must ensure that all operational agreements with Midland Freight are closely monitored to sustain company growth and to maximize owners wealth.