Target Corporation is currently seeking additional capital to expand its operations. Two companies have shown interest in providing additional capital. Company #1 is interested in investing in the organization and, therefore, would like to have part ownership through the sale of new stock. Company #2 is interested in providing a loan to the Target Corporation. Both organizations need to know more about the financial stability of Target. As an employee of Target, your supervisor needs you to write a memo in which you explain what information from the Target Corporation's financial statements will be highlighted when representatives of Target meet with each of these companies. In your memo, be sure to explain which information will be highlighted to Company #1 and which information will be highlighted to Company #2 and why. Explain any differences in the information that you have chosen to highlight.

MEMORANDUM

To : Finance Manager

From : Assistant Finance Manager

Subject: Information To Be Highlighted for Presentation to Companies Interested in Providing Additional Capital to Target Corporation

As you know, our company Target Corporation is in an expansionary phase of business, and is seeking additional capital to expand the business. We have been in the process of discussion with companies willing to provide us with the additional capital required- and through negotiations, have narrowed down the possibilities to two companies, Company #1 (Equity Corporation) and Company # 2 (Debt Corporation). We have scheduled the final meetings with the representatives of both companies in the coming week. As per your instructions, I have determined the important points that each of the two companies should be interested in, and am presenting it below for your consideration.

For Company 1: Equity Corporation

The representatives of Equity Corporation have indicated that they would like to finance the additional capital by making an investment in our company i.e. through the purchase of new stock. In this case we would have to take into account the number of ordinary and preference shares already outstanding on the books of Target Corporation. Additional issue of Stock to Equity Corporation would in effect dilute the earnings of the existing shareholders. We would have to see if the shares to be issued would be Preference Shares or Ordinary Shares. In case of preference shares carrying preferential rights the rate of the preferential rights would have to be determined. However, the advantage to Target Corporation in financing the additional capital through equity is that the payment of dividends to the shareholders is not mandatory; Target can hold on to its profits and re-invest them in the company to strengthen its growth efforts. Therefore if we go for equity financing, it is recommended for the issue of simple Ordinary shares to Equity Corporation. These would carry the minimal burden for Target Corporation. The issue of equity capital would strengthen the debt:equity ratio as it would show a healthier picture of equity compared to debt levels. This means that additional capital through debt from other sources is also a possibility in future years, as lenders would be favorably inclined to lend to a company that has a strong equity base and is not debt-heavy.

As equity shareholders, the company would be interested in the

(1) price to earnings ratio: Price per share of common stock/ Earnings per share of common stock.
The higher the ratio, the better. This would be compared to other firms in the same industry.

(2) the dividend payout ratio: Dividends per share/ Earnings per share. It is the ratio of earnings paid out to earnings made. Also compared to industry averages. Higher the ratio, the better.

(3) the dividend yield: Dividends per share/ Market price per share. It is a measure of dividends paid to market price. Compared to industry averages. Higher the ratio, the better.

(4) the book value per share. Is a measure of the historical value of the firm’s assets, on a per share basis. Higher the ratio, the better.

For Company 2: Debt Corporation

The representatives of Debt Corporation have indicated that they are interested in funding the additional capital to Target Corporation by giving us a loan. This would amount to debt capital and would attract interest, which is a fixed cost for the business. Moreover the interest would have to be paid whether or not the company made a profit in future years. We would have to secure the loan granted by some of our assets. Taking a loan would also affect the debt:equity ratio of the company, and would make it difficult to take on additional debt in the future.

As potential creditors of the company, Debt Corporation would be interested in the

(1) Current Ratio: Total Current Assets/ Total Current Liabilities. This gives a picture of the short term liquidity of the business. Should indicate sufficient coverage. While a ratio of 2:1 is ideal, this should be compared to industry averages.

(2) Quick Ratio: Total Current Assets less Inventories/ Total Current Liabilities. Shows the ability to meet current obligations under adverse conditions. Normally a ratio of close to 1:1 is sufficient.

(3) Total Debt to Assets: Total Debt/ Total Assets. Shows the percentage of the business financed by debt. Remainder is the portion financed by equity. Lower ratio is desired.

(4) Times Interest Earned: Operating Income/ Interest Expense. Gives an idea of the ability of the firm to make its interest payments. Higher the coverage, the better.

Besides this, both companies would also look at the projected rate of sales growth of the company’s products, the nature, type and mix of its inventories, personnel and management, the company’s operating cycle, the activity ratios and the gross and net profit margins of the company compared to other firms in the same sector of industry.