CONTINENTAL CARRIERS

FM group no 9
Sneha Chandra(PGP 29342),Anurag Khetan(PGP 30302),Chitra Venkatesh(PGP
30307),Nikhil Madan(PGP 30323)

INTRODUCTION
Continental Carriers Inc is a regulated general commodities motor carrier who had
shipping routes up and down the Pacific Coast and to parts of the Midwest. They
sought to acquire Midland Freight Inc to expand its operations and were deliberating
about which method to finance the acquisition. The purchase of Midland Freight Inc
would cost $50 million in cash. CCI would gain $8.4 million to its earnings before
interest and tax. There were three options that the board of directors debated over:
issuing new common stock, issuing preferred stock or selling bonds. As Ms. Thorp,
evaluate the impact of the bond issue and of the stock issue on the EPS. What are
the risks in each alternative? The bond alternative arranges to sell $50 million in
bonds to a California insurance company with an interest rate of 10 percent at
maturity of 15 years. There is $2.5 million sinking fund required which leaves $12.5
million outstanding at maturity. The issues with this method are as follows: Longterm-debt can be burdensome and can stunt or slow growth of the company. The
company has to payback what was borrowed plus the interest on the debt. It also
puts stockholders and management who are primary holders of stock at risk,
because if the company earnings are substantially lower than what was forecasted
then the bondholders can virtually gain control of company. The second alternative
would be the possibility of issuing new common stock of 3 million shares offered at
$17.75 per share. This would bring the total common stock to 4.5 million shares
outstanding. There would be many concerns if CCI decided to issue new common
stock. The introduction of new shares would hurt present shareholders because it
would dilute the stock and bring the value down in terms of EPS. If there is more
shareholders then whatever increased earnings, if any, are reaped then it has to be
shared with old and new shareholders. This creates more dependency on
shareholders resulting in less flexibility for the company. There can also be a loss of
control because stockholders are effectively owners of the company. The volatility of
the stock price can be greatly affected if there is one large equity holder. Also taxes
would be greater because tax shield would not be applicable with this option
The methods available are:
A) Selling $50 million in bonds at a 10% interest rate to a California insurance
company and with maturity of 15 years.
B) Issuing $3 million in common stocks at $17.75 per share with dividend rate of
$1.25 per share.

C) Issuing 500,000 preference shares at a par of $100 per share and with a dividend
rate of $10.50 per share.

Objectives
To determine the best financing source that will maximize the wealth of the
companys owners.
To study the advantages and disadvantages of acquiring Midland freight Inc.

Areas of Consideration
Internal & External Analysis
Strengths
A successful performer financially market confidence in its capability for
continued revenue growth
Acquisition or growth oriented
Low operating cost
The company does not pay any interest expense currently as it has no long term
debt
Rated attractive above average return performance
Weaknesses
Policy of avoiding long term debt
Alternative Strategies
Presented below are the options available to the company
Option 1: Bond/Debt Financing:
Advantages
Lower taxes
Has a positive DFL change in EBIT will positively impact EPS
High debt ratio resulting from firms degree of indebtness and high financial
leverage
Least cost of financing
Higher EPS than stock
Higher potential return

 Using debt to raise funds will be seen positively by shareholders as they would be
capturing the total increase in stock value
No dividends

Disadvantage
Greater financial risk
Payment of interest
Option 2: Preferred Stock Financing:
Advantages
Outflows consist only of dividend payments
No principal has to be paid in future
No interest payment
Disadvantages
High Cost of issuance
Issuing these brings no additional benefit to the company as the market value
remains the same
High taxes

Option 3 Common Stock Financing:

Advantages
No principal as to be paid in future
No interest payment
Disadvantages
Uncertainty of the offering price for the new common stock provide reasons for
raising funds through debt
High cost of issuance
High taxes
In this case, the company is in a quandary of choosing the most beneficial option.
Here are some of the points the company should consider to meet its objectives:
1. Through getting the income and dividend data for 1988, before the effects of the
acquisition can be reflected, the current operating and financial position of the
Continental Carriers, Inc. must first be evaluated.

2.Consider the effects (positive or negative) of the acquisition on earnings before

interest and taxes, interest expense, tax expense, dividends and key financial
indicators such as the degree of financial leverage, the debt ratio, earnings per
share, and the resulting effective interest rate under each of the alternatives. This
will help the company to overview which alternative will contribute the most
remuneration with the assessment and comparison to the current situation and to
other alternatives.
3. It will be advisable for the company to graphically
4. For each financing plan, it would be functional for the company to graphically
characterize the correlation between the EPS and EBIT.
5. All cash inflows and outflows for the 15 years should be verified with each
alternative form of financing this will result to exposure to the achievability of
pursuing any one strategy, showing the companys expected revenues and costs.
(Only disparity costs and revenues tied to each approach should be used in the
study).
6. All qualitative factors should be taken into consideration which has greater
effects in the decision such as company policy and market performance.
Maximization of wealth of existing stockholders, utilization of future earnings and
diminution of risk should be the basis on the companys preference of financing

Recommendations
With regard to the evaluation and analysis that we have made, we offer to carry out
the acquisition of long term debt through selling of $50 million worth of bonds to a
California Insurance Company. The best advantage of this option is its lower cost of
financing as compared to the issuance of stock which is the main goal of the
Continental Carriers, Inc. Another thing is, even though the use of bonds will not
increase after-tax earnings, it is still preferable because the bond issue results in
interest expenses which are tax deductible. There is also a sinking fund which
through this, the company will have more than enough left to pay its common stock
shareholder resulting to the uninterrupted betterment of the market perception of
the companys stock.
Through this option, Continental Carriers, Inc. can grab the opportunity of having a
high EBIT which is justified by a high Degree of Financial Leverage.