The target Debt to Equity ratio

Based on calculations we recommend Galveston should enter the shrimp processing business. The project generates a positive NPV of its investment. Based on the data available from Ocean foods and Treasure Isle, we calculated the companies individual Levered Betas to be 0.42 and 0.83. We then unlevered both companies Beta, using the target Debt to Equity ratio, giving us the average unlevered Beta of the shrimp processing industry of 0.39. At the target Debt to Value level of 30%, we calculated the shrimp processing's business Return on Asset rate (Ra) to be 10.11%. Levering the average unlevered Beta at the target D/E ratio, we were then able to calculate the Return on Equity (Re) to be 10.97%

1. Estimate the unlevered beta for the shrimp processing business using the data provided in Should Galveston Fishing Company enter the shrimp processing business based on your answers to 7&8? Yes. Because NPV is greater than zero. 10. Galveston Fishing Company contemplates about borrowing $10 for the project and structure the new division as a stand alone entity. The loan will be secured by the assets and future cash flows of the project, not by the parent company. The loan has a maturity of 5 years and carries interest rate of 11%. The principle is payable at end of 2009. Estimate the NPVL of the project for Galveston with this new financing possibility. (In your answer, also assume that the firm will maintain a 30% debt/value ratio after the year 2009.)

There was also an offer to finance this project by the municipality of Brownsville, Texas. The municipality offered Galveston Fishing Company a $10 million loan for 5 years to build the shrimp processing plant in Brownsville. The financial terms of the loan stipulated that only interest payments would be paid at 5% during 2005-2009 and the entire amount of the principal of $10 million was due at the end of 2009 as a single payment). The investment bankers of Galveston Fishing Company finance group estimated that the market interest rate of a comparable debt instrument, if placed privately and secured by the project, would have been 11%.

Estimate the NPVL of the project for Galveston with this new financing possibility. (In your answer, again assume that the firm will maintain a 30% debt/value ratio after the year 2009.) While the main interest of a shareholder would be to know how much profit PQR is making and depending on that how much dividends would he expect, all I can comment on is the present performance of PQR in terms of profitability.

The company has demonstrated a significant improvement in its net margin despite the fall in gross profits. Overall the gross profits have declined from 10.42% in 2002 to 10.17% in 2004. Despite this, the rise in net margins from 5.42% in 2002 to 5.79% in 2004 shows that the company is better managed now. It is trying to be more competitive (increased sales) at the same time maintain its profit margins. PQR has achieved this mainly by reducing costs. This means the money invested by you is working harder for the business, which can be seen in ROCE ratio. It has risen from 13.60% in 2002 to 14.76% in 2004. Overall in terms of profitability the business is progressing slowly but steadily and I should assume that the profit margins would keep on rising in the near future if managed with same consistency.

Liquidity

It would not be sensible to draw final conclusions as to the liquidity of PQR based on the balance sheet figures. As a balance sheet is based at one point of time it can sometimes be misleading, as reading of figures over a period of time would be more appropriate. It would be hard to say what ratio would be suitable for PQR as there is no definite answer. Current Asset ratios were quite high in 2002 (4.30:1) and 2003(3.50:1), which have been decreased in 2004 (2.63:1).

Acid Test ratio shows that business had its money being tied up with debtors for a longer period in 2002 (1.54:1) and 2003 (1.83:1), which dropped in 2004 (1.29:1). This reflects better management and control. Overall the business doesn't have any liquidity problems and it has been more efficient with its finances as the Current Asset ratio and Acid Test ratio suggests, however it will need to make sure that any investment made in fixed assets is utilised more efficiently by the business in generating more sales.

Efficiency

The stock turnover ratio has improved from 60.83 days in 2002 to 47.33 days in 2004. This means that the business is being more efficient in reducing its storage costs and it also means that the business is not tying up it money in unwanted stock. Due to an improved stock turnover it would also help PQR to respond to market changes quickly. The credit control at PQR has improved from 60.83 days in 2002 to 47.33 days in 2004.

This again shows an improved efficiency and should help PQR in maintain a good cash flow. Fixed Asset Turnover ratio is the only ratio where PQR hasn't improved a lot. The ratio increased from 3.60 (2002) to 4.20 times in 2003, which shows better utilisation of fixed assets. However this figure dropped in 2004 to 2.67 times. This was mainly because of an investment in fixed asset. It would be important to see whether this figure improves in the near future.