BUSINESS ORGANIZATIONS Ross and Westerfield graduated from UC in 2012 with a masters degree in marketing and
Question:
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BUSINESS ORGANIZATIONS
Ross and Westerfield graduated from UC in 2012 with a masters degree in marketing and public health. They established a healthcare business in 2013. The business sourced and distributed pharmaceutical products in the United States. Ross and Westerfield have been partners for several years sharing profits and losses equally. Their partnership business has been very successful, as they agree on most business-related issues. One disagreement, however, is about the legal form of their business organization. Ross wants Westerfield to agree to changing the business from a partnership to a corporation. Ross believes that there is no major problem with corporations and incorporating the business would attract investors to help them raise large capital to expand the business internationally. Westerfield thinks otherwise and believes that the business should remain a partnership to avoid any agency problems. Ross & Westerfield want you to help them address the following questions:
1. What are the advantages and disadvantages of changing the business organization from a partnership to a corporation?
2. Ross and Westerfield know that limited partnerships, limited liability companies, and corporations enjoy limited liability, but they are not very sure what that means. Explain the concept of limited liability to Ross and Westerfield.
3. Assuming Ross and Westerfield have invested $5.0 million in the business. If the company happens to declare bankrupt and has $6 million in unpaid debts. Explain the nature of payments, if any, by Ross and Westerfield in each of the following situations:
i. The company continues as a partnership
ii. The company changes to a corporation
4. If Ross and Westerfield decides to go for a corporation they would like to consider alternative methods of issuing new securities (i.e., raising long-term funds) and the costs of issuing securities in the market.
i. Distinguish between a public issue and a private issue of raising long-term funds and give two examples of each.
ii. Identify five examples of flotation costs associated with issuing securities in financial markets that Ross and Westerfield must consider if they decide to go public.
PART 2. FINANCIAL STATEMENT ANALYSIS AND FINANCIAL MODELS
Ross and Westerfield want to use financial planning models to prepare a projected (pro forma) financial statement to determine the profitability and financial health of the business for next four years if they go public. The income statement ending Dec 31, 2020, and the companys balance sheet as at Dec 31, 2020, are shown below. Use the financial statement to answer the following questions:
INCOME STATEMENT
($millions)
Total operating revenues
102
Less expenses
47
Less depreciation
10
Earnings before interest and taxes
45
Less interest
3
Net income before taxes
42
Less taxes @ 24%
10
Net income
32
BALANCE SHEET
Assets:
Cash
25
Other current assets
38
Net Fixed Assets
30
Total Assets
93
Liabilities and Equities:
Accounts payable
15
Long-term debt
18
Stockholders' Equity
60
Total Liabilities & Equities
93
5. What was companys profitfor 2020?
6. Compute the following three profitability ratios and explain to Ross and Westerfield whether the business did better or worse in 2020 relative to the performance of the industry.
i. Profit margin
ii. Return on assets
iii. Return on equity, and
iv). Calculate and explain operating cash flow
The industry ratios are as follows:
Industry ratios
Profit margin
30.80%
Return on assets
32.00%
Return on equity
42.50%
Current ratio 3 times
Total debt ratio 40.0%
7. The business current assets comprise of cash and other current assets whilst its current liabilities comprise of only accounts payable. Compute and explain the current ratio and total debt ratio for the business in 2020.
8. Ross believes that if the business goes public large capital can be raised to increase sales and cash flows to maximize the value of the firm. Assuming the business projects a 35% increase in operating revenue (sales) per year what will be the anticipated operating revenue in three years from now (i.e., in 2023)?
9. If net income is projected to increase by 30% per year, what will be the profit margin in 2023?
10. What will be the estimated earnings per share (EPS) in 2023 if 5 million shares are issued?