Financing Options

Option 1 Option 1 utilizes 100% debt. The JSL group would take out a private loan in the amount of $35 million (or 48.6% of the total cost) at 6% interest. The city would back the remaining $37 million (that is, 51.4% of the total cost) by issuing bonds at 3.75% interest. This would be partially backed with general obligation bonds from San Marcos residents (which still require voter approval), and partially with revenue from the facil- ity itself. A city can issue a general obligation bond through the bond market. Typically, a general city-issued general obligation bond is supported by an increase in citizens property taxes. This is why issuing a general obligation bond requires voter approval. Also, because the bond is backed by property taxes, the city is often able to receive favorable interest rates for the on the bond. This is one benefit JSL has in partnering with the city of San Marcos (for more on the municipal bond process, see Howard & Crompton, 2004). The annual debt payment (10 years @ 6%) for the $35 million is $4,662,861.08. The annual debt payment on the bonds (interest payments + sinking fund principal obligations for 10 years @ 3.75%) is $4,442,719.20.

Option 2 Option 2 utilizes 60% city-backed debt at 4.25% interest (i.e., $43.2 million). This would be paid back through a visitor tax increase on hotels and rental cars, as well as revenue from the facility itself. This tax increase does not require voter approval. The remaining 40% would be offered to preferred limited stock- holders. This preferred stock would be offered at $45/share. The dividend expected would be $5 per share and the flotation cost is an inexpensive $1.50 per share. The annual debt payment on this form of financing ($43.2 million for 10 years @ 4.25% interest) is $5,310,361.73.

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San Marcos Municipal Events Center: A Capital Budgeting Case

SAGE Business Cases

SAGE

2013 Human Kinetics, Inc.

Option 3 Option 3 utilizes a mix of private loans and limited private stock ownership of the facility. In this op- tion, JSL owns 25% of the facility through a limited private stock offering to its internal partners. This would be offered at $43/share, with a $3 dividend and $2 flotation cost. Then, JSL finances an additional 30% through private bank loans (so that its total controlling share is 55%). These loans, totaling $21,600,000, are issued at 6%. The final 45% of the facility will be offered as a limited private sale of common stock to the residents of San Marcos, then surrounding communities. This stock will sell for $20/share with a $2 dividend, $2 flotation cost, and 1.5% growth rate. The annual debt payment on this form of financing (interest + principal for 10 years @ 6%) is $2,877,651.41.

Your Task

After this initial examination of the data, the task force has hired you as a consultant to help them make their final analysis and recommendations on the project. Your job is to utilize the revenue and cost to calculate the cash flows from the facility, calculate the WACC of the three project options, and then compute the returns (using NPV and IRR) of the three options. After a full analysis of the cash flows and the returns, you are to prepare a recommendation to the city and JSL concerning the best course of action for financing the new facility from both political and financial perspectives. Note: you do not need to analyze whether or not the project is feasible, but only the best financing option given the projected cash flows from the project.

Please follow the outline below in preparing your report:

1. Estimate the cash flows from the project over a 10 year project life. (Use the 7 year de- preciation schedule attached in Appendix A with no depreciation in years 9, 10). You can use the template provided below in Figure 1.

2. Using cash flows, calculate IRR for the project over a 10 year time period.

3. Calculate the WACC for each of the financing options provided above.

4. Use the Time Value of Money formulas to calculate the NPV for each of the financing op-

   tions. Use the WACC for each option as the discount rate for that option.

5. List three strengths and three weaknesses of each financing optionbe sure to consider your ability to make your debt payments on top of existing operational costs (i.e., after you have your final cash flows for each yearcould you make the debt payment for each

   option?).

6. Provide an overall recommendation to the city based on your analysis. Your recommen-

   dation should include both financial and socio-political considerations.