Financing an Expansion
Expanding a business requires significant financial resources and various financial assessments. Upon reviewing the firm’s financial status and establishing whether expansion is possible, it is crucial to evaluate whether acquiring another firm, such as a competitor, is beneficial. The acquisition plans should be funded through various financing options as indicated by valuation methods like the primary venture capital valuation. Further, competitor analysis is necessary to determine which firm will contribute positively to the expansion plans upon the acquisition. Competitor analysis will also help establish whether the intended firm for acquisition shares strategies, capabilities, and objectives similar to those of the acquiring firm. Essentially, these aspects are given attention in assessing the financing of an expansion for the wash and auto detailing business that was started.
This particular assignment is financing an expansion plan to acquire a competitor called Expert Car Cleaner in California. The competitor is well-known and controls a significant market share. However, the business has recently faced financial difficulties and found it challenging to generate profits. The company made a net loss in the past two years for the first time since its establishment in 2008. Considering the stiff competition in the market, it is unlikely that the business can recover quickly and return to its profit-making ways. Thus, the owners will be open to an acquisition plan. Therefore, it is the primary expansion plan for my Wash and auto detailing business.
The income and market valuation techniques are selected to evaluate the Expert car cleaner company. The income valuation technique considers the business’s earning potential to its owners. The income valuation approach is commonly used to gather important information, such as the company’s discretionary earnings and discounted cash flows. Many operators in California’s car wash industry generate up to $50 million in profits annually. Expert cleaners have consistently accounted for about 15% of this income before running into losses in the past two years. It is therefore assumed that acquiring this firm will contribute to improved profit margins for our business as it recovers to maintain its former profit margins.
It is essential to consider the discretionary flow of our competitors. An estimation of the competitor’s cash flow in the last three years was $2,500,000, $3,400,000, and $2,000,000. On average, obtained from the three years, the business has a weighted average of $2,633,000. The evaluation further entails considering the income from our business to establish the income of the two companies, assuming they were working as one business. It is shown that profits of $5,942,000 would have been achieved. Obtaining the value is done by considering the income projections for our company for three years and getting their weighted average. The weighted average is then added to the Expert car cleaner business.
The discounted cash flow valuation technique utilizes a discounted rate, net cash flow, and the anticipated gain to determine the value of the business. Notably, this valuation is vital in determining how the process of acquiring the competitor is conducted. Considering the information in the next fiscal period, the following information from the competitor would have been crucial in obtaining the discounted cash flow of the company:
- Revenue generated in the fiscal period of the entire operation in 2023 is estimated to be $3,232,000. Essentially, it is assumed that the business will be at optimal operations.
- Salaries to workers would be $54,000 with no salary increments after the acquisition.
- Additional equipment for the operation would cost $44,000
- Miscellaneous expenses costing $12,300 would be incurred
- The total operating profit estimated would be $1,476,000
- Taxes amounting to $442,800 would be paid, which is obtained as 30% of the government’s operating profits.
- Upon acquisition, the anticipated net income in the first year of operation will be $1,033,200. The net income will be expected to grow steadily in the following years at a rate of 5% per year. The increase will run for at least five subsequent years.
A discount rate of 20% will be used to discount future cash flows. The intended positive outcomes from the business are on the assumption that customers will remain dedicated to the company beyond the acquisition as more customers are obtained. Further, it is assumed that the industry conditions will remain stable because they have remained stable in the past one and a half decades. Holding the assumptions alongside the profitability figures generated above, the Expert Cleaner car will cost $3,800,000 to acquire.
It is established that Expert Car Cleaner is a lucrative venture that will not only increase income for our company but also reduce competition. It is essential, thus, to figure out the options available for us to obtain financing for the acquisition. The financing options must be affordable and cause no harm to our business. It is essential to consider various financing strategies and opportunities and select the best. One aspect of being evaluated is the income statements, which are critical in giving insight into the profitability of a business. Our company’s income statements are imperative tools that banks and other financial institutions will assess to determine how much they can give us (Palepu et al., 2020). The income statement indicates the outflows and inflows of our business. However, income statements should be evaluated alongside the statement of financial position. Notably, this is so because the balance sheet gives important information regarding the worth of the business and debts held by the company.
Debt is an inevitable option for financing the intended acquisition. The market involves two primary options: loan financing and equity financing. Loan financing entails the loans offered by financial institutions and other lending institutions to businesses to undertake their operations. In obtaining loan financing, collateral is required by the lending institutions, whereby the collateral will be used in the place of the loan in the case of a default on repayment. It was noted that our business would use both equity and debt financing to fulfill the expansion objective.
The debt option includes short-term and long-term loans. Short-term loans are typically paid within a year, while long-term loans are delivered in a period longer than one year (Coleman et al., 2016). A long-term loan option will be used to fund the expansion plan for the intended expansion. The loan will be obtained from one of the banks in the surrounding. One of our premises will be used as collateral in acquiring the loan. Another debt option to consider will be the line of credit. Essentially, this financing option benefits a firm because no limitations are attached to the funds regarding their use. Also, the line of credit incorporates lower interest rates than loans. Notably, this option will be evaluated against the loan option to assess the better option. The selection criteria will involve the easier option to pay for and acquire.
Equity financing will also be considered in financing the expansion. The approach entails using internal resources to raise capital. Half of the required finance will be presented using this option. Essentially, it will entail selling shares to various stakeholders, such as employees and the general public. It is worth noting that obtaining finance through this option interferes with ownership of the company and, consequently, the decision-making process. This is why the option is not the only one considered to finance the expansion plans.
A cross-comparison between debt and equity to determine where to ideally obtain the required $100 million to fund the expansion plans. As informed by the above assessment of debt and equity financing options, both approaches will be taken. $50 million will be raised through debt, while the remaining half will be raised through equity financing. The decision to use both options is to take advantage of each option and reduce the risks and disadvantages involved in each option. For instance, the debt option does not dilute the company’s ownership like equity financing. However, the company bears a risk of losing properties in the case of a default on the loan payment. On the other hand, equity financing has advantages that entail no collaterals and no restriction on the use of money obtained (Goh et al., 2017). Thus, better leverage on each option’s disadvantages and advantages will entail using the two options equally to fund the expansion.
Coleman, S., Cotei, C., & Farhat, J. (2016). The debt-equity financing decisions of US startup firms. Journal of Economics and Finance, 40(1), 105-126.
Goh, B. W., Lim, C. Y., Lobo, G. J., & Tong, Y. H. (2017). Conditional conservatism and debt versus equity financing. Contemporary Accounting Research, 34(1), 216-251.
Palepu, K. G., Healy, P. M., Wright, S., Bradbury, M., & Coulton, J. (2020). Business analysis and valuation: Using financial statements. Cengage AU.
We’ll write everything from scratch
Overview: (THE BUSINESS VENTURE IS WASH & AUTO DETAILING)
After 12 years, your business is wildly successful, with multiple regional locations. You are now ready to think big. You want to purchase a tremendous competitor. (Note: You determine whether the competitor is a privately or publicly held company.) You will need additional capital from the debt or equity market or both to expand.
Write a 5–7 page paper in which you:
Use one of the valuation techniques identified in Chapters 11 and 12 to calculate the value of the competitor you wish to purchase. Note: You must make assumptions; however, your assumptions must be rationally supported.
Analyze the various financial tools available to you to determine which tools will be most helpful in assessing whether your company can afford to purchase the competitor. Support your response.
Imagine you can indeed afford to purchase the competitor; however, you will need an additional $100 million.
Examine the options available to finance the competitor through the debt market, recommending the best alternative as a result of your analysis. Provide support for your recommendation.
Examine the options available to finance the competitor through the equity market, recommending the best alternative as a result of your analysis. Provide support for your recommendation.
Conduct a cross-comparison of your debt and equity examinations to determine where to obtain the additional $100 million funding needed to make the purchase and the approach you would take to securing the funds. Provide support for your recommendation.
This course requires the use of Strayer Writing Standards. For assistance and information, please refer to the Strayer Writing Standards link in the left-hand menu of your course. Check with your professor for any additional instructions.
The specific course learning outcome associated with this assignment is:
Determine whether to use the debt market or the equity market to obtain and secure funding for a significant business purchase.