You are CFO of xyz Co. Your firm faces the following choices that are mutually e

Question

You are CFO of xyz Co. Your firm faces the following choices that are mutually exclusive. Which would you choose?

Increase next year’s NI by $70 mil. Increase LT Debt by $280 mil. and increase xyz’s market value by $490 mil.

Increase next year’s NI by $140 mil. Increase LT Debt by $70 mil. and increase xyz’s market value by $280 mil.

Increase next year’s NI by $705 mil. Increase LT Debt by $140 mil. and increase xyz’s market value by $165 mil.

Increase next year’s NI by $140 mil. Increase LT Debt by $70 mil. and increase xyz’s market value by $340 mil.

Increase next year’s NI by $210 mil. Increase LT Debt by $210 mil. and increase xyz’s market value by $420 mil.

Explanation / Answer

Ans. As a CFO, I would want to see a control on the debt side, how much cashflow the company is generating, and the impact of that in the market.. So, if the market vlaue is good the sentiments are strong we can raise more equity through public if needed, and can also work on getting more debt as well. The best option is 4th from a company point of view, and from investor point of view it can be 3rd or 4th

Here the situation is also compared taking book value by market value. The book value is the difference between the no and Debt for the year.

Also, it is assumed that there is no cashflow in the previous year or was at 0. Usually if the value is less than 1 it is vover valued, and if more than 1 then under values. The same can eb used to caclucate market to book value if more than 1 it is over priced.

Here we can see in botht hte cases the fourth  instance where the increase in NI by 565 and LT Debt 165 million, We can see for third BV/MV is less than 1, and MV/BV is close to 1 which shows that share has some vlaue. With respect to this the third option is better for normination.

Also, it is visible with the debt the amount of cashflow reduces, which causes the weak financials. The company will have more cash in hand to use and dispose as well. . It does not show good for the company as well, the finnacial stress increases as well.

Here from the stand point of only the debt we see, whcih is helpful to see how the lenders value the investment. It can be 3 or 4th, but from investor's point of view 5th is better. Although high debt will give tax beinifts, and may lead to values with integration. Here if it iassumed that previous year is no reserve, and the value is directly added. Asset=liability + share holder equity (assuming share holder equity has the value). Liability will be the debt. Liability=Debt+free cahsflow to equity holder

The best option is 4th

S.NO Niv(in $) Debt (In $) Free cashflow to Equity holder Market Value (In $) BV/MV MV/BV 1 70 280 -210 490 -0.42857 -2.33333 2 140 70 70 280 0.25 4 3 705 140 565 165 3.424242 0.292035 4 140 70 70 340 0.205882 4.857143 5 210 21 189 420 0.45 2.222222

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