Finance 4210 - Friendly Cards

Finance 4210 - Friendly Cards

Introduction:

Mrs. Beaumont is the president of Friendly cards Inc. As it stands in the current moment. She is having discussions with her consultants about the future of the company. She is going to have to make a decision on a couple of different strategic moves that she is currently presented with. Her challenge is that her company is seeing steady growth and can expect to see a 20% increase in sales moving forward. The issue with growth is that, in order for her to be able to produce enough product to meet rising demands, she is going to require more capital. It is a bit of a tricky situation seeing as her source of debt funding has places some covenants over the company in order for the company to keep lending through the years which are limiting due to the nature of the highly seasonal demand which calls for a lot more spending power during certain parts of the year, more so than the slower parts of the year. The nature of these decisions are going to have a large impact on the future of the company and it is important to make the right decision.

Her three decisions come down to the following:

1.Whether or not she should buy an envelope machine to lower her operating expenses which will help to generate more positive cash flows.

2. She needs to decide whether or not to acquire Creative designs Inc.

3. Also needs to decide whether or not she should go to the market to raise equity capital despite currently crippling market conditions.

Among these three decisions our President is faced with, we will also need to consider some relevant facts that pertain to this case.

We need to take a look at the Cyclical Nature of the industry, the threat of industry consolidation, and also the inherently high fixed costs associated with Friendly Cards production efforts.

Preparation questions:

Should Friendly Cards purchase the envelope machine? If so, how?

Normally we could use a calculated WACC to discount stated cash flows but we do not have that information provided in the case. Sub sequentially if we calculate an IRR value for this project by first coming up with a Net operating profit after tax, adding back depreciation, accounting for change in NWC and also factor in the initial cost of the equipment of 500,000 we are able to generate our cash flows. Once we have done that we can calculate an IRR on the assumption that the envelope machine does not have a Terminal value. When I calculated for IRR I was able to come up with a number of 41%. When we are looking at this number we naturally want it to be a value above zero which would insinuate that the project is worthwhile. Having a 41% IRR on a project is going to benefit this company and Mrs. Beaumont should absolutely make the purchase to start producing her own envelopes. Doing so would reduce their costs and influence their net revenues positively. One important potential issue to factor looking at a company that is already in a cash dependent position to take into account is the up front cost of the machine. Mrs. Beaumont could potentially source the funding for this machine by issuing equity despite the bearish nature of the market.

(Refer to Exhibit 4 for numbers figured.)

2. Should Friendly Cards acquire Creative Designs?

In order to figure whether or not Friendly Cards should acquire Creative designs, we first need to come up with  a CAPM(Which requires an estimated beta of CD. ) and also a figured WACC. Before I explain how to calculate an estimated equity beta, it is important to note that we need to consider. Projected cash flows and also do a valuation with Mrs. Beaudmonts ability to increase sales /reduce costs, and then do one without those assumptions being made.

3. Should Friendly Cards accept the offer of the West Coast Investors and issue new equity?

Suggestions:

1. Valuation of the envelope machine

• Calculate IRR (not enough info for appropriate cost of capital)
•  Does the IRR look poor, so-so, or good?

1. Valuing creative designs

• DCF valuation  
• Estimate cash flows, WACC. For WACC estimation, use a target 45% Debt/Total capital ratio for the acquisition
• Ignore any change on FC’s capital structure as a result of acquisition at this target

1. Issuing stock

• Is cash needed by Friendly Cards? If so why?
• Is issuing equity the best way for Friendly Cards to raise funds?

Case Summary:

1988 wendy Beaumont president

Ms. McConville: Financial Consultant.

Comments that cost of financing growth is high

Expected 20% increase in sales

Youre figuring out how to want to finance the Growth of the company.

Big 3 dominate the scene with overwhelming market share.

Larger more diversified product lines. More efficient distribution channels.

Between 1954 to 1984 theres a 15% decrease in total number of firms.

To compete, you deal with high fixed costs. High inventory costs because you need to keep stock for re-orders.

Seasonal Peaks. Dollar sales

32% on Christmas

7% Valentines Day

5% mothers day

2% fathers day.

Operations:

1200 designs of greeting cards.

Target market was primarily to over 40 year olds.

Cost conscious.

250 employee plant in reading. Completely integrated. From art work to printing and packaging.

Plant is at capacity but printing could be done by outside printers if necessary.

Low margins due to direct sales with employees on direct commissions. No two intermediaries.