Information Zeller & Merkel, Inc. (ZM) is a mid-sized high-tech manufacturing firm that has taken you on as an intern. You are very thankful for this opportunity, especially as Tim Zeller and Christine Merkel are known for giving their interns opportunities to use their accounting knowledge by asking for the student’s evaluation of important scenarios in a live business. A good example is ZM’s current plan to raise money through a stock issue rather than a debt issue. You recall from your Intermediate Accounting class that issuing debt imposes a fixed financial obligation on the company, but does not convey ownership to the debt holders. However, if ZM issues stock, it gives up some ownership and thus some control. You know Zeller and Merkel are protective of the company, and you wonder why they would choose to issue stock. You decide to ask them the next day.
ZM is very receptive of your inquiry, and they invite you to give your evaluation and opinion on the following 5 scenarios they have been considering for raising the necessary money for expansion:
Issue $10,000,000 of 10-year bonds with a coupon rate of 4%, interest payable semiannually. Although the current market rate is 4%, based on current economic forecasts, Zeller and Merkel recognize that market rates might increase to 6% by the time they issue the bonds. Although they do not like the option of added debt, they feel it is a reasonable alternative and should be considered. However, they are not clear on the implications that this bond issue would have on the company and its financial statements, including the impact of the possibility that interest rates might increase by the time the bonds could be actually issued.
Zeller and Merkel do realize that they could also outright borrow the $10,000,000 from a financial institution, but again are unclear as to the impact on the financial statements. In addition to describing that impact, they also ask you to compare the advantages and disadvantages of raising the monies via a bond issue versus a loan.
A third possibility is to issue 2,600,000 shares of common stock ($2 par value) to current shareholders and a selected group of new investors (a private issue). They have been advised to price the stock to sell at ZM’ s book value per share at the end of 2017. In addition to wanting to know the advantages and disadvantages of using this private issue to raise capital, they also ask you to clarify what is meant by “book value per share” and what implications that would have on this scenario.
The company does have some shares held in the treasury, and wonder if that might be another viable alternative to raising the needed funds. Zeller and Merkel are curious to see if you know what impact this alternative would have on the company and its financials.
The fifth option is to proceed with an initial public offering (IPO). Based on current and anticipated economic conditions, the resurgence of the IPO market, and interest in high-tech companies, Zeller and Merkel think they could get an IPO price of around $5 per share. At this price, they would need to issue approximately 2,000,000 shares.
Prepare a detailed and thorough business memo in good business format describing the advantages and disadvantages of each scenario described above. Keep in mind that you are writing to entrepreneurs, not accountants. Which alternative would you recommend and why? Be sure to justify your answer by comparing the merits of raising capital through bonds, loans, and common stock. Keep in mind that you will need to document your memo with references as to the sources of any outside information as Zeller and Merkel will want to know where the information came from.