A CASE ANALYSIS OF

FARNSWORTH FURNITURE INDUSTRIES Presented by
Avash Bhattarai Baburam Subedi Himalaya Ban Pragati Dahal

Ritu Malekoo
Rubina Shrestha Somnath Kandel

Venue: Uniglobe College ,Sunday July 7, 2013

PART I

Case Highlights
 

Farnsworth Furniture established in 1932 is one of the largest manufacturers in the US It is known for providing excellent design, quality craftsmanship at fair prices. During the mid-1980s, the demand for pine furniture increased due to falling interest rates and willingness of homeowners to spend extra money furnishing their houses To meet the increased demand, Farnsworth Furniture Industries is undertaking a major capital expansion program with approximately $50 million in new capital $25 million has already been borrowed as a long term loan form a group of five insurance companies. To raise an additional $25 million through the sale of common stock.

Company’s alternative proposals
P1
• Go for IPO at subscription price of $53 per share where $3 will be charged as commission
• Issue rights share to the existing shareholders at a subscription price of $50 where commission will be charges as $1.50 per share and Commission for unsubscribed shares is $4. • Issue rights share at a price of $44 per share with underwriting cost of $1 for each subscribed and $4 for each unsubscribed • Sell shares to current stockholders at subscription price of $27 with underwriting cost of $0.25 for the subscribed shares and $4 per share taken by the investment banker. • Sell shares to current stockholders at subscription price of $5 per share.

P2

P3

P4

P5

PART II DATA ANALYSIS AND FINDINGS

Issue 1
Proposa Subscriptio Floatatio l n Price (PS) n Cost (FC) 1 2 3 $ 53 $ 50 $ 44 $3 $ 1.5 $1
Price Received per Share
(PS -

FC)

No. of Additional Share 5,00,000 5,15,464 5,81,395 9,34,579 50,00,000

$ 50 $ 48.5 $ 43

4
5

$ 27
$5

$ 0.25
0

$ 26.75
$5

Issue 2
No. of Proposal Old Share No. of No. of Right New Share C=A÷B

(A)
2 3 40,00,000 40,00,000

(B)
5,15,464 5,81,395 7.76 6.88 4.28

4

40,00,000

9,34,579

If subscription price goes on decreasing then the number of Right purchase share is also declining. There is positive relation between number of right and subscription price.

Issue 3
Proposal 2 3 4 PO $ 54 $ 54 $ 54 PS $ 50 $ 44 $ 27 Alpha(α) 7.76 6.88 4.28 Vr $ 0.457 $ 1.269 $ 5.114

5

$ 54

$5

0.8

$ 27.22

The relation between subscription price and value of right is negative. As increase in value of rights, is decreasing the subscriptions price of share. So, lower value of right less dilute the market price of share.

Issue 4
MPS Proposal [A] [B] [C = A-B] Vr Ex-right PS

2
3 4 5

$ 54
$ 54 $ 54 $ 54

$ 0.457
$ 1.269 $ 5.114 $ 27.22

$ 53.543
$ 52.731 $ 48.886 $ 26.78

$ 50
$ 44 $ 27 $5

We can observe from give table that the as the subscription price goes on declining, the ex-right price is also goes on declining. There is positive relation between subscription price and ex-right price.

Issue 5
Proposal PO PE Stock Dividend 0.854% 2.407% 10.461% Proposal

2 3 4 5

$ 54 $ 54 $ 54 $ 54

$ 53.543 $ 52.731 $ 48.886 $ 26.78

2 3 4 5

101.643%

If we undertake the right offering this is equivalent to stock dividend, whether we pay higher or lower stock dividend. As a subscription price goes on decrease, percentage of stock dividend goes on increasing. There is a negative relation between subscription price share and percentage of stock dividend.

Issue 6
Assets Old assets Add: New assets

Amount in Millions
$ 155.61 $ 25

Liabilities and Capital Accounts Payable Bank Loans Total current liabilities Long-term debt Capital Stock Add: New Common stock Retained earning Total Equity

Amount in Millions $ 16.12 $ 22.94 $ 39.06 $ 33 $ 22 $ 25 $ 61.55 $ 108.55 $ 180.61

Total assets

$ 180.61

Total liabilities & capital

Issue 6
Proposal 1 2 3 4 5 TE (A) $18.06 $18.06 $18.06 $18.06 $18.06 NAS (B) 5,00,000 5,15,464 5,81,395 9,34,579 50,00,000 NTOS (C) = EPS 4 million + (D) = A ÷ C (B) 45,00,000 45,15,464 45,81,395 49,34,579 90,00,000 $4.013 $4 $3.942 $3.66 $2.007

This table shows the total earning of company after issued of common stock, newly issued no. of share, no. of total outstanding share and Earning Per Share (EPS) of different proposal. We can see the decreasing trend of EPS as the proposal change from 1st to 5th. Thus as the subscription price goes on declining, EPS also decline consequently MPS also decline, so there is positive relationship between them.

Issue 6
MPS Proposal P/E Ratio EPS (P/E Ratio × EPS) 1 2 20 20 $4.013 $4 $80.26 $80

3
4

20
20

$3.942
$3.66

$78.84
$73.2

5

20

$2.007

$40.14

The MPS under each proposal 2, 3, 4, and $80.26 are $80, $78.84, $73.2, and $40.14 respectively. We can see the MPS is decreasing in coming proposal of 2, 3, 4 and 5th. As the subscription price goes on declining, earning per share as well as market price per share is also declining. So, there is a positive relation between subscription price and earnings per share and market price per share.

Issue 7
Proposal Ex- Right MPS as per Issue 4 1 Ex- Right MPS as per Issue 6 $ 80

$ 53.543

2
3 4

$ 52.731
$ 48.886

$ 78.84
$ 73.2 $ 40.14

$ 26.78

In case of question number 6, the prices per share after issue of the new shares under each of the four proposal without using formula is calculated using below assumptions:  Earning is assumed to be 10 percentage of total asset: The earning may not be 10% which is not realistic.  Current liabilities remain at 2006 level: Amount of liabilities may vary according to the operation business, so it is not sure that liabilities will remain in same level of 2007.  The assumption of new outside capital will employed be fully may be wrong because it is affected by different factors affect it.  Price earnings ratio is assumed to be 20 which may not be true in reality.

Issue 8: Maximum and minimum floatation costs under each of the proposals
Proposal Probability of no rights being exercised Probability of 100% of the rights being exercised 1 2 0.25 3 4 5

0.15 0.05 0.00

-

0.75

0.85 0.95 1.00

For Proposal 1: Expected Flotation Cost = Number of shares to be issued * Floatation cost per share = 500,000 * $3 = $1,500,000 Expected Flotation costs in % = Expected floatation cost/ Funds Required = ($1,500,000/ $25,000,000) * 100% = 6%

Maxi floatation cost For Proposal 2, 3, 4 & 5
Calculation of flotation cost if no rights are exercised (If 0% right is exercise)
Particulars Funds required Subscription Price per share Floatation Cost per share issued (A) Price Received per Share for Unsubscribed Shares No. of New Share to be (B) Total flotation cost (A × B) Proposal 2 25,000,000 50 Proposal 3 Proposal 4 Proposal 5 25,000,000 25,000,000 25,000,000 44 27 5

4
46 543,478 $2,173,913

4
40 625,000

4
23 1,086,957

0
5 5,000,000 0

$2,500,000 $4,347,826

No. of shares to be issued = Fund required ÷ Price received per share Price received per share = Subscription price – Floatation cost Flotation cost = Number of shares to be issued × Floatation cost per share

Mini floatation cost For Proposal 2, 3, 4 & 5
Calculation of flotation cost if all rights are exercised (If 100% right is exercise)
Particulars Proposal 2 Proposal 3 Proposal 4 Proposal 5 25,000,000 25,000,000 25,000,000 25,000,000

Funds required
Subscription Price per share Floatation Cost per share issued (A) Price Received per Share for Unsubscribed Shares New Share to be Issued (B) Total flotation cost (A × B)

50
1.5 48.5 515,464 $773,196

44
1 43 581,395 $581,395

27
0.25 26.75 934,579 $233,645

5
0 5 5,000,000 0

Expected flotation cost for proposal 2,3,4 &5
Particulars Probability (no rights are exercised) (A) Probability (all rights are exercised) (B) Flotation cost(no rights are exercised) (C) Flotation cost(all rights are exercised) (D) Expected flotation cost [(A*C) + (B*D)] Expected Flotation costs in percentage Proposal 2 0.25 0.75 $2,173,913 $773,196 $1,123,375 4.494% Proposal 3 0.15 0.85 $2,500,000 $581,395 $869,186 3.477% Proposal 4 0.05 0.95 $4,347,826 $233,645 $439,354 1.757% Proposal 5 0 1 0 0 0 0

Expected Flotation costs in percentage = Expected floatation cost÷ Funds Required

Issue 9
If the company undertakes rights offering, as opposed to an offering to the general public then it will enhance the shareholders loyalty. In addition existing shareholder get following benefits:  In the right offering the existing stockholders get the first option to buy any issue of new stock.  The subscription price is less than the current market price of the stock. Therefore stockholders are able to buy additional shares at a price lower than the prevailing market price.  Right offering would also preserve the control power and ownership of the existing stockholders.  Reduce chance of dilution in earnings per share of the company; it means the earnings of the company would not be distributed among large number of stockholders. Thus, if company is offering the rights to its stockholders, it is said to be showing loyalty to existing stockholders than by offering to the general public.

Issue 10
Proposal 1 Advantages Disadvantage:
 

Wider distribution of stock to throughout the market. Number of knowledgeable shareholder will be high. Public awareness towards company will increase. Dilution of earnings per share is less, because no of share to be issued is less

No loyalty to existing shareholders Floatation cost is highest Issue could be a failure because subscription price is higher

Issue 10
Proposal 2 Advantages Disadvantage

Loyalty to existing shareholders will increase. Dilution in earnings per share is less i.e. No. of share outstanding is 5, 15,464.

 

Small shareholders may not exercise the right because subscription price is $44. Expected Floatation cost is still higher i.e. 4.49% Small discount margin is currently available in company share. Issue could be failure (PS) is high. Stock dividend effect is Nonnoticeable i.e. 0.85%. No wider distribution of stock

Issue 10
Proposal 3 Advantages Disadvantage
 Stock

 Loyalty

to existing shareholders will increase.  Expected Floatation cost is relatively low i.e. 3.44%  Dilution in earnings per share is less i.e. No. of share outstanding is 5,81,395

dividends is still not noticeable i.e. 2.407%  Right have low value, here VR = $ 1.269  Issue could be failure because subscription price is $ 44.  Small shareholder may not exercise the right.  No wider distribution of stock to throughout the market.

Issue 10
Proposal 4 Advantages Disadvantage
 Loyalty

to existing shareholder  Subscription price is considerably lower so chance of exercising right would increase.  Expected floatation cost is quite low i.e. 1.757%  Huge discount margin ($ 54 - $ 27 = $ 27) is the major benefit to shareholder.  Noticeable stock dividend effect i.e. 10.461%

$

5.114 is high right value.  Dilution in EPS is more because we are going to issue 9, 34,579 shares which are large in number.  No wider distribution of stock to throughout the market.

Issue 10
Proposal 5

Advantages
 Issue

Disadvantage
 Dilution

cannot be a failure because subscription price is lowest i.e. $ 5.  Floatation cost in zero.  101.643% of a large stock dividend effect from which existing shareholder will largely benefit.  Huge discount margin ($ 54 - $ 5 = $ 49) is the major benefit to shareholder.

in earnings per share is more, here number is additional share is 5 millions  Cost of administrating the share will goes up.  If any shareholders are not able to exercise the right, he/she is going to suffer a loss.  High value of right i.e. $ 27.22  Investment bank will become unhappy.  No wider distribution of stock to throughout the market.

Decision
Hruska should recommend the proposal 4 to the board of directors as the best method of common stock financing. Proposal 4 seems to be more favorable than other alternative proposals, because of the following reasons:  Floatation cost is relatively low.  Issue cannot be a failure because subscription price is considerably lower so chance of ex-right would increase. Offer huge discount margin ($ 54 - $ 27 = $ 27) to shareholders.  No chance to hurt company image and maintain the stock in a popular trading range.  Lastly, proposal 1 and 5 seems too extreme type of proposal and proposal 4 is average type of proposal in compare to other offer proposal 2 and 3.

PART III

CONCLUSION

While choosing the alternative we need to consider various aspects of the company. like flotation cost, company reputation ,distribution of shares, and loyalty. So, in this case also several alternative were available but eventfully we come to choose alternative 4 due to low floatation cost; high discount margin; Low subscription price and no outrage of share from existing shareholder. Hence several factors do play crucial role in issue of additional funds in form of common stock because it affects the company’s flexibility, control and dilution of ownership.

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