Continental Carriers, Inc. (CCI) is a U.S. trucking company that is looking into getting a loan for the purchase of another company. Since the company directors have conflicting stands on taking on a debt, it was hard for CCI to come up with a decision.
W. Carl Kester
Harvard Business Review (291080-PDF-ENG)
June 25, 1991
Case questions answered:
- Considering Continental Carriers, Inc.’s capital structure, and given the nature of the business, how much debt can it support?
i. Evaluate the question from the interest coverage ratio perspective,.
- Consider the EBIT chart. What information can you extract from it?
- Which Financing alternative is best for shareholders? Consider the impact of each, in turn, on the following:
i. EPS level
ii. EPS growth
iii. EPS Volatility.
iv. Capacity to pay dividends
- Why not assume a lot of debt?
- Does the sale of new shares pose any risks or potential problems?
i. In what sense, if any, will the sale of new shares “dilute” the stock of existing shareholders?
- What do you recommend Continental Carriers, Inc. to do?
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Case answers for Continental Carriers, Inc.
This case solution includes an Excel file with calculations.
CONTINENTAL CARRIERS, INC. (CCI)
MIDLAND ACQUISITION EXECUTIVE SUMMARY
Overview of the Company – Continental Carriers, Inc. (CCI)
Continental Carriers, Inc. (CCI) is a motor carrier founded in 1952. In 1982, CCI went public. In 1988 planned to buy Midland Freight, Inc in a $50M cash takeover. Midland Freight, Inc will bring to CCI $8.4M in EBIT per year. CCI’s policy of stable dividends and avoiding long-term debt (stock offering or short-term bank loans).
How to Finance Midland Acquisition?
Directors’ Challenges & Analysis
Director 1 – PRO-EQUITY
- Cost of debt at 8% (the sinking fund is missing)
- Stock issuance has a smaller cost than bonds
- Bond added risk to Continental Carriers, Inc. causing stock volatility
Director 2 – PRO-DEBT
- Against stock issuance, because the acquisition would net $5M (or 10%)
- Additional dividend of $4.5M is required
Director 3 – PRO-DEBT
- $17.75 per share is a “steal”
- Book value of the company is $45 per share in 1987
- Dilution of management voting rights
Director 4 and 5 – PRO-DEBT
- Post-acquisition earning of $34M (before interest and taxes = EBIT)
- Dilution of EPS to $2.72 if common stocks are sold
- EPS up to $3.87 if only debt is used
Director 6 – MIXED/OTHER
- Continental Carriers, Inc. has no long-term debt, while EPS is the lowest in the industry
- Preferred stock (not to be taken into account)
How Much Debt can CCI Support?
Interest Coverage with $50m New Bond is…