Sara Lehn, chief financial officer of Merit Enterprise Corp., was reviewing her

Question

Sara Lehn, chief financial officer of Merit Enterprise Corp., was reviewing her

presentation one last time before her upcoming meeting with the board of directors.

Merit’s business had been brisk for the last 2 years, and the company’s CEO

was pushing for a dramatic expansion of Merit’s production capacity. Executing the

CEO’s plans would require $4 billion in capital in addition to $2 billion in excess

cash that the firm had built up. Sara’s immediate task was to brief the board on options

for raising the needed $4 billion.

Unlike most companies its size, Merit had maintained its status as a private

company, financing its growth by reinvesting profits and, when necessary, borrowing

from banks. Whether Merit could follow that same strategy to raise the $4 billion

necessary to expand at the pace envisioned by the firm’s CEO was uncertain,

although it seemed unlikely to Sara. She had identified the following two options for

the board to consider.

Option 1: Merit could approach JPMorgan Chase, a bank that had served Merit

well for many years with seasonal credit lines as well as medium-term loans. Lehn

believed that JPMorgan was unlikely to make a $4 billion loan to Merit on its own,

but it could probably gather a group of banks together to make a loan of this magnitude.

However, the banks would undoubtedly demand that Merit limit further borrowing

and provide JPMorgan with periodic financial disclosures so that it could

monitor Merit’s financial condition as Merit expanded its operations.

Option 2: Merit could convert to public ownership, issuing stock to the public

in the primary market. With Merit’s excellent financial performance in recent years,

Sara thought that its stock could command a high price in the market and that many

investors would want to participate in any stock offering that Merit conducted.

Becoming a public company would also allow Merit, for the first time, to offer

employees compensation in the form of stock or stock options, thereby creating

stronger incentives for employees to help the firm succeed. On the other hand, Sara

knew that public companies faced extensive disclosure requirements and other regulations

that Merit had never had to confront as a private firm. Furthermore, with

stock trading in the secondary market, who knew what kind of individuals or institutions

might wind up holding a large chunk of Merit stock?

TO DO

a. Discuss the pros and cons of option 1, and prioritize your thoughts. What are the

most positive aspects of this option, and what are the biggest drawbacks?

b. Do the same for option 2.

c. Which option do you think that Sara should recommend to the board, and why?

Explanation / Answer

Option 1:

Advantages & Disadvantages:

Advantages:

Disadvantages:

Option 2:

Disadvantages:

c) I feel that Sara should recommend option 1 i.e. borrowing loans from JP Morgan or any other group banks, because considering the above pros & cons of both the options, when the company goes public, it would be forced to disclose all its sensitive information & there are chances that some investors will take over the control of the company from the management which would be risky for the company.

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