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Living Smart Inc. has decided to expand its operations to owningand operating long-term health care facilities. The following is anexcerpt from a conversation between the chief executive officer,Mark Vierra, and the vice president of finance, Jolin Kilcup.

Mark: Jolin, have you given any thought to how we

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Tod Thiel
Tod ThielLv2
28 Sep 2019

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Preferred Stock vs. Bonds

Xentec Inc. has decided to expand its operations to owning andoperating golf courses. The following is an except from aconversation between the chief executive officer, Peter Kilgallon,and the vice president of finance, Dan Baron.

Peter: - Dan, have you given anythought to how we’re going to the acquisition of Sweeping BluffGolf Course?

Dan: - Well, the two basic options, asI see it, are to issue either preferred stock or bonds. The equitymarket is a little depressed right now. The rumor is that theFederal Reserve’s Bank’s going to increase the interest rateseither this month or next.

Peter: - Yes, I’ve heard the rumor. Theproblem is that we can’t wait around to see what’s going to happen.We’ll have to move on this next week if we want any chance tocomplete the acquisition of Sweeping Bluff Golf Course.

Dan: - Well, the bond market is strongright now. Maybe we should issue debit this time around.

Peter: - That’s what I would have guessed as well.Sweeping Bluff Gold Course’s financial statements look pretty good,except for the volatility of its income and cash flows. But that’scharacteristics of the industry.

Discuss the advantages and disadvantages of issuingpreferred stock versus bonds.

Capital Expenditures Budget On January 1, 2016, the controllerof Omicron Inc. is planning capital expenditures for the years2016–2019. The following interviews helped the controller collectthe necessary information for the capital expenditures budget:Director of Facilities: A construction contract was signed in late2015 for the construction of a new factory building at a contractcost of $10,000,000. The construction is scheduled to begin in 2016and be completed in 2017. Vice President of Manufacturing: Once thenew factory building is finished, we plan to purchase $1.5 millionin equipment in late 2017. I expect that an additional $200,000will be needed early in the following year (2018) to test andinstall the equipment before we can begin production. If salescontinue to grow, I expect we'll need to invest another $1,000,000in equipment in 2019. Chief Operating Officer: We have really beengrowing lately. I wouldn't be surprised if we need to expand thesize of our new factory building in 2019 by at least 35%.Fortunately, we expect inflation to have minimal impact onconstruction costs over the next four years. Additionally, I wouldexpect the cost of the expansion to be proportional to the size ofthe expansion. Director of Information Systems: We need to upgradeour information systems to wireless network technology. It doesn'tmake sense to do this until after the new factory building iscompleted and producing product. During 2018, once the factory isup and running, we should equip the whole facility with wirelesstechnology. I think it would cost us $800,000 today to install thetechnology. However, prices have been dropping by 25% per year, soit should be less expensive at a later date. Chief FinancialOfficer: I am excited about our long-term prospects. My onlyshort-term concern is managing our cash flow while we expend the$4,000,000 of construction costs on the portion of the new factorybuilding scheduled to be completed in 2016. Use this interviewinformation to prepare a capital expenditures budget for OmicronInc. for the years 2016–2019. Enter all amounts as positivenumbers. Omicron Inc. Capital Expenditures Budget For the FourYears Ending December 31, 2016-2019 2016 2017 2018 2019 Building $$ $ Equipment $ Information systems Total

Acme Inc. is a wholesaler and distributor of electricalcomponents. The most recent draft financial statements of thebusiness revealed the following:

Income Statement for the Year (in millions)

Sales revenue 14.2

Opening inventories 3.2

Purchases 8.4

Goods available for sale 11.6

Closing inventories (3.8)

Cost of goods sold (7.8)

Gross profit 6.4

Administration expenses (3.0)

Distribution expenses (2.1)

Operating profit 1.3

Finance costs (0.8)

Profit before taxation (0.5)

Tax (0.2)

Profit for the period 0.3

Statement of Financial Positions as at the End of the Year (inMillions)

ASSETS

Noncurrent Assets

Property, plant, and equipment

Land and buildings 4.0

Equipment 1.1

Motor vehicles 0.4

Current Assets 5.5

Inventories 3.8

Trade receivables 2.9

Cash at bank 0.2

Total Assets 12.4

EQUITY AND LIABILITIES

Equity

Share capital 2.1

Retained earning 1.6

Noncurrent Liabilities 3.7

Loan notes (secured on property) 3.9

Current Liabilities

Trade payables 2.2

Short-term borrowings 2.6

4.8

Total equity and liabilities 12.4

Additional information: Land and buildings are shown at theircurrent market value. Equipment and motor vehicles are shown attheir carrying amount (that is, cost less accumulateddepreciation).  No dividends have been paid to ordinaryshareholders for the past three years.

In recent months, suppliers (trade payables) have been pressingfor payment. The chief executive has, consequently, decided toreduce their level to an average of 40 days outstanding. To achievethis, she has decided to approach the bank with a view toincreasing the overdraft (the short-term borrowings consist of onlya bank overdraft). The business is currently paying 10 percent ayear interest on the overdraft.

Identify four sources of finance (internal or external, butexcluding a bank overdraft) that may be suitable to finance thereduction in trade payables, and state, with reasons, which ofthese you consider the most appropriate.

Based on the information given, complete the followingtasks:

Comment on the liquidity position of the business.

Calculate the amount of finance required to reduce tradepayables, from the level shown on the statement of financialposition, to an average of 40 days outstanding.

State, with reasons, how you consider the bank would react tothe proposal to grant an additional overdraft facility.

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