Pacific Grove Spice Company has been rapidly growing and earning profits as a manufacturer and distributor of quality spices and seasonings. As part of its business practices, the company enters into investment contracts with its accounts receivable, inventory, and fixed assets. Interest-bearing debts of the company ballooned to a point where the bank was concerned and asked the company to reduce them. As part of this case study, students analyze financial projections of a company to meet the bank's request for reducing interest-bearing debts.
William E. Fruhan and Craig Stephenson
Harvard Business Review (4366-PDF-ENG)
November 17, 2011
Case questions answered:
Case study questions answered in the first solution:
- Pacific Grove Spice Company has a great opportunity to partner with Lesley Buller. It can also sell $11 million of its common stock to outside investors, and for $13 million of its stock, it can acquire High Country Seasonings. How do the CEO and the company itself select from among these alternatives for maximum shareholder benefit?
Case study questions answered in the second solution:
- Give you practice in using the tools of financial analysis, including financial projections, financial ratio analysis, funding requirements, and debt constraints and covenants.
- Illustrate the loss to existing shareholders created by issuing new common stock to external investors.
- Review the valuation of an entire company, including estimation of the appropriate risk-adjusted cost of capital and free cash flows to investors.
- Review and consider capital structure issues, the value of financial flexibility, the costs of financial distress, financial policy and execution, and two alternatives for issuing new common stock.
- Facilitate understanding of the close interaction between investment and financing decisions.
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Pacific Grove Spice Company Case Answers
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Pacific Grove Spice Company
Due to the financial crisis of 2008, the banks are under pressure from regulators to limit exposure to potential loan losses. Therefore, Pacific Grove Spice Company’s bank recently told the company’s management to reduce the debt-bearing interest to less than 55% of total assets and the equity multiplier to less than 2.7 times by June 30, 2012. The bank will refuse to extend any additional credit if the company fails to meet these requirements.
Despite bank requirements, the company is also evaluating other opportunities to finance growth. This memo aims to assess all the other available opportunities and recommends the company with the best alternative to go forward.
Recently, the company was approached by a cable cooking network to produce and sponsor a new program that could increase the company sales by an additional $8.1 million in the fiscal year 2011 and by 5% every year for the next five years.
In addition to operating expenses, the company would have to incur an upfront cost of $1.4 million and incremental working capital every year.
The financial analysis predicts that this project would have a positive NPV in the baseline scenario, the best-case scenario, and the worst-case scenario.
It would be only negative in the worst-case scenario when the discount rate is 20%. Pacific Grove Spice Company cannot ask the bank to finance this project.
The company also cannot use the retained earnings because the retained earnings are not enough to fund further growth in assets to support ever-increasing sales.
The only available option for financing this program is by raising equity, but due to the financial crisis of 2008, the financial market is experiencing volatility, which would make the sale of new stock more difficult and possibly more expensive. Therefore, the company might not be able to pursue this alternative.
Peterson, CEO of the Pacific Grove Spice Company, also approached outside investors to sell new common stock to finance the growth and reduce the company’s total debt.
If the company chooses this alternative, the company would be…
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