Golden Gate Aircraft is a medium-sized aircraft company located just outside San

Question

Golden Gate Aircraft is a medium-sized aircraft company located just outside San Francisco whose sales distribution is approximately 30 percent for defense contracts and 70 percent for nonmilitary uses. The company has been growing steadily in recent years, and projections based on current research-and-development prospects call for continued growth at a rate of 5 percent to 7 percent a year. Although recent reports of several brokerage firms suggest that the firm’s rate of growth might be slowing down because of the high price of fuel and the softness of the business aircraft market, Golden Gate’s management believes, based on internal information, that no decline is in sight. The company’s stock, which is traded on the Pacific Stock Exchange, is selling at 15 times earnings. This is slightly below the 17 times ratio of Standard & Poor’s aircraft industry average. The company has assets of $35 million and a debt ratio of 25 percent (the industry average is 23 percent). Golden Gate needs an additional $5 million over and above additions to retained earnings to support the projected level of growth during the next 12 months.

To raise addition fund, which one should be used? Long term bonds, common stock convertible debentures. Explain your answer.

Explanation / Answer

The company should use euity - common stock to rasie the additional funding of $5 Million required.

The debt ratio of the compnay is already 25% which is higher than the industry average of 23%. Hence taking on additional debt can further increase the debt ratio and make it even more difficult for the company to service the debt. hence the company should avoid long term bonds.

The same applied for convertible debentures, since debenture is also a type of debt instrument and this also will make the debt ratio greater and make it difficilut for the company to survive on the long run.

Hence raising additional funds through common stock equity would be the best. Although the industry is suffering due to strong fuel prices and general softness in the aircraft business, the firm can go for equity since the price earnings is lower than that of the industry and it would be the best option to raise additonal capital

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