The Nothing But Cheese (NBC) Company is a small but successful family owned business that specializes in family photography in wholesome circumstances. The company conducts still and video photography of individuals and families in settings that can best be described as â€œheart- warming.â€� NBCâ€™s photographic techniques are unique, incorporating several patented photographic equipment innovations and improvements. The company fully expects to dominate its market niche within the region in the foreseeable future.
The firm has been in existence for over 40 years and has had a long-term philosophy of â€œno debtâ€� and â€œfamily control.â€� Currently 5,000 shares of $1 par value common stock are outstanding, all of which are held by family members. NBCâ€™s shareholdersâ€™ equity section of its December 31, 1996 balance sheet contained the following data:
Common stock: $1 par value, 100,000 shares
authorized, 5,000 shares issued
Additional paid-in capital in excess of par value
Total shareholdersâ€™ equity
Sophia Fuji, NBCâ€™s current president, has found three alternative ways of raising additional capital that would be used for both current operating purposes and an expansion to neighboring regions.
â€¢ Alternative 1: Issue 40,000 shares of six percent, $100 par value cumulative preferred stock to a local but very wealthy investor. Each share could be converted to four shares of common stock anytime after the year 2000.
â€¢ Alternative 2: Borrow $4,000,000 from a local bank at 10 percent with a maturity date at the end of the year 2000.
â€¢ Alternative 3: Transform NBC immediately into a public company by issuing 500,000 shares of common stock at an estimated price of $8 per share. Of course, any member of the Fuji family could purchase stock on the open market at the issue date or at any later date.
a. Has NBC been successful in the past? Has it been profitable? What information is needed to answer these questions?
b. How can it obtain cash for expansion or operating purposes if none of these options is successful? In other words, what other options could Sophia also pursue?
c. Show the effects on the shareholdersâ€™ equity section of NBCâ€™s balance sheet from each of the three alternatives identified earlier by Sophia.
d. Noting that interest is deductible for tax purposes, while dividends are not, evaluate the advantages and disadvantages of each of the three options. Show the effects on net income of each option.
e. Write a short memo from Sophia to her relatives, recommending one of the three options, while at the same time criticizing the other two options.
f. One of Sophiaâ€™s more vocal and complaining relatives responds to your memo and suggests that each of the three options is too expensive and threatens the loss of family control. He suggests that the family members must invest the additional $4,000,000 through purchase of additional shares. Because Sophia has already been told that other Fuji family members will not consider this option, write a short but tactful memo from Sophia to the dissenting family, indicating why your recommendation above (part e) is still preferable.