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Corporate Finance

Corporate Finance

BUSINESS ORGANIZATIONS

Jaffe Desk and Jordan Reilly just graduated from UC with a master’s degree in marketing and public health. They want to establish healthcare business that will source and distribute pharmaceutical products in the United States and internationally. Jaffe and Jordan know that before they can invest their time and other resources in the project, they must obtain financing, which means that they must raise money to pay for the investment cost and other operating expenses. Because the company might not be listed in any capital market right away, they will not be able to raise equity funding from the public. Therefore, they are considering raising long-term capital from various sources including angel investors, venture capital market, bank loans, crowdfunding, and initial coin offerings (ICOs). They learnt in corporate finance course the advantages and disadvantages of different forms of business organizations. They are worried about the legal concept of limited liabilityand how it will affect their personal fortunes in the future in case the business fails. They are not very sure which form of business organization to set up to protect their personal liability, reduce taxes, and access external funding. Therefore, they are considering a partnership, a limited liability, or a corporation.  A cash budget they prepared shows that $5 million seed money would be needed to hire staff, buy computers, rent an office space, promote, and market the business as well as to meet other business development expenditures. They have agreed to share profits and losses equally if they decide to form a limited partnership. The general partner will, however, be paid a fixed salary of $6,000 per month before taxes and other payroll deductions.

In order to make good and right decision, Jaffe and Jordan have approached you to help them understand the concept of limited liability, advantages, and disadvantages of the various forms of business organizations and possible sources of funding for the business.

  1. Explain the legal concept of limited liability to Jaffe and Jordan
  2. Give 2 advantages and 2 disadvantages of each of the following forms of business organization to Jaffe and Jordan:
    • partnership,
    • limited liability, and
    • corporation

3. Ultimately, what form of business organization would you recommend Jaffe and Jordan to consider. Why?

  1. Based on your recommendation above, explain to Jaffe and Jordan if the following sources of raising long-term capital are appropriate for them:
    • angel investors (angels)
    • crowdfunding
    • venture capital
    • initial coin offering, and
    • long-term debt

PART 2. FINANCIAL STATEMENT ANALYSIS AND FINANCIAL MODELS

Jaffe and Jordan want to use financial planning models to prepare a projected (pro forma) financial statement to determine the profitability and financial health of the business for next year, ending Dec 31, 2022. Use the pro forma financial statement below to answer the following questions:

PRO FORMA INCOME STATEMENT

($millions)

Total operating revenues

82

Less expenses

27

Less depreciation

9

Earnings before interest and taxes

46

Less interest

4

Net income before taxes

42

Less taxes @ 23.8%

10

Net income

32

PRO FORMA BALANCE SHEET

Assets:

Cash

19

Other current assets

28

Net Fixed Assets

40

Total Assets

87

Liabilities and Equities:

Accounts payable

12

Long-term debt

28

Stockholders’ Equity

47

Total Liabilities & Equities

87

5. What is the estimated profit of the business for 2021?

6.  Compute the following profitability ratios and explain to Jaffe and Jordan whether the business looks profitable relative to the performance of the industry.

i. Profit margin

ii. Return on assets

iii. Return on equity

iv. calculate and explain operating cash flow

The industry ratios are as follows:

Industry ratios

Profit margin

32.80%

Return on assets

34.00%

Return on equity

42.50%

7. Assuming you project a 25% increase in operating revenue (sales) per year what will be the anticipated operating revenue in 2022?

8.  If net income is projected to increase by 20% per year, what will be the profit margin in 2022?

9. What will be the estimated earnings per share (EPS) in 2022 if 1,000,000 shares are issued?

10. In the near future Jaffe and Jordan might like to go public by selling 60% of their interests in the business to strategic investors in the financial market. This might create a conflict of interest between the owners and the strategic investors. Explain agency relationship to Jaffe and Jordan and give one example of an agency problem that could occur between the owners and the strategic investors.


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