Schooner Yachts is a closely held company that was founded in 1970 by Russ Break

Question

Schooner Yachts is a closely held company that was founded in 1970 by
Russ Breaker to build a top-quality line of sailboats. The company’s debt ratio is 48 percent,
compared to an average ratio of 36 percent for sailboat companies in general. The stock is
owned in equal parts by ten individuals, none of whom is in a position to put additional
funds into the business. Sales for the most recent year were $12 million, and earnings after
taxes amounted to $720,000. Total assets, as of the latest balance sheet, were $9.6 million.
Schooner Yachts needs an additional $4 million to finance expansion during the current fiscal
year. Given the worldwide growth in leisure-time activities and interest in sailing in particular,
the firm can anticipate additional outside capital needs in the years ahead.

Should the company use private placement of debt, public offering of debt or ordinary shares public offering to raise additional funds? Explain your answer.

Explanation / Answer

Total assets on the balance sheet are given as $9.6 million

So since debt ratio is given as 48%, total debt on balance sheet is = 48% * 9.6 = $4.61 million

If company goes for additional debt, then this raises to = 4.61 + 4 = 8.61. In this case debt ratio would be 8.61 / 13.6 = 63.29%.

This would be much more than the industry average. And also if anyone is ready to invest in the debt of this company, they would implement lot of covenants on additional fund raising, which is essential in future as per given facts.

And also present equity investors are not ready to invest any more money, so there is only 1 option of raising money which is through public offering i.e. company going public. This has many advantages, some of them are listed below

- Debt to Equity ratio will be brought down. Which is necessary to be in line with competitors

- No limitation on additional funds raise in future

- Since sailing market is going to be good in future, stock price will increase in boom years.

So company should raise additional funds by issuing ordinary shares public offering.

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