Generally Accepted Accounting Principles and Carlton Essay Example

formula: outstanding debt * Rd * (1+g){Rd-g}. Overall, after assigning different weights to the scenarios, the purchase price is determined to be $2,226,340.It is important to mention that the stability of the interest rate, tax rate, and inflation rate is assumed.

Relative valuation was used to compare the P/E ratios of Oakite Products and Economics Laboratory, which were considered the most comparable companies. We assigned a weight of 65% to Economics Laboratory and 35% to Oakie. Based on this method, the firm value is calculated as $9,796,600 and the selling price is $3,187,580. Taking into account this valuation, our recommendation is for Charlie Carlton to purchase Jim Miller's shares. This advice is primarily based on the APV valuation purchase price, as we believe the relative valuation may not provide an accurate estimate.

We believe that the comparable firms have too many dissimilarities from Carlton to use their P/E ratios in our valuation. According to our NPV valuation, the purchase price is lower than the estimated selling price of $2.500.000, if Charlie were to pay this amount, he would overpay by approximately $300.000. Therefore, we recommend that Charlie pays no more than $2.226.000 for the 50% share of the company.

However, it is assumed that Charlie will be able to repay the bank loan required for financing this deal.

Term Sheet

When a bank grants a loan, its goal is to ensure repayment of the debt by the borrower.

After examining Carlton's profile, it is evident that they are a promising candidate for a loan. The company has consistently surpassed industry standards in terms of growth rate over multiple years and has maintained steady margins. Furthermore, the Debt Service Coverage Ratio remains

higher than one even after considering all existing debt, indicating the company's ability to fully repay its obligations. Additionally, the Interest Service Coverage Ratio remains above 1, demonstrating Carlton's capacity to meet interest payments even in unfavorable conditions. Therefore, when evaluating financing options for Carlton, credit risk concerns are minimal for the bank.

However, it would be prudent for the bank to reassess their term sheet by offering senior debt at a low-interest rate and securing it with collateral. This will help mitigate potential risks that may arise from unforeseen circumstances exacerbating projected scenarios.

The bank may not receive the full amount owed by Carlton, as other obligations like taxes have higher priority. If the bank requests collateral, it can be sold to repay the loan. Hence, senior debt is considered less risky with a relatively low interest rate. To further reduce risk, the bank can enhance the term sheet. The bank should modify the term related to executive compensation, as currently executives can potentially raise their compensation based on sales growth.

In order to provide a comprehensive compensation agreement, it is important to consider including a clause that allows for adjustments in compensation in the event of negative growth. Additionally, the agreement should address the possibility that the company may be unable to make interest or debt payments. To incentivize timely repayment, the company could implement fees for overdue payments. Alternatively, the bank could have some level of control over the company's operations if payments are not made on time. This would serve as a strategy to identify instances of mismanagement or financial difficulties.

The operational aspect of Carlton is limited by various terms, including restrictions on working

capital, capital expenditures, and lease agreements. These limitations hinder Carlton's potential for future growth. It is uncertain how Carlton can maintain its high-growth status in the long run without significant expansion opportunities in the next 5 years. To address this issue, it would be beneficial to reduce these constraints and instead determine the maximum percentage of sales that can be allocated to capital expenditures, working capital, and entering into lease agreements.

The financing for this transaction follows a structure where Miller will receive $2.5 million, with $1.5 million being paid in cash.

The funding for this project will come from a loan of $1,365,000 from the bank and $135,000 from excess cash. The remaining amount will be paid through a $1 million note to Miller. When evaluating whether the debt raised is excessive based on Standard median financial ratio rating, we consider all three possible scenarios for Carlton and their corresponding rating. We find that the interest coverage ratio meets the requirements for a BBB rating, with only the worst-case scenario receiving a BB rating in terms of interest and full rental coverage. The operating income and sales ratio indicate a high rating.

Based on the rating given, there is no indication of default. The amount of debt associated with this bank loan is not excessive. Furthermore, even in unfavorable situations, the Debt Service Coverage Ratio indicates that it can adequately cover both principal payments and interest throughout the loan's entire duration. Therefore, based on this ratio, we can determine that the debt from this bank loan will be fully covered and is not excessive. Additionally, we examined the Z-ratios.

In 1968, Edward Altman created Altman's Z, a tool

for evaluating the financial well-being of a company. Altman's Z utilizes multiple discriminant analysis to assess a firm's financial health and offers a helpful guideline for predicting financial distress. By examining the 1982 financial statement and employing the formula designed for private companies, Altman's Z reveals that a company with a score of 5.08 is considered highly stable and secure. Furthermore, even after undergoing restructuring, a score of 6.01 reinforces the company's resilience and suggests it is unlikely to face bankruptcy.

Alternative Financing Options

The goal of the company is to obtain funding equivalent to 50% of its current value in order to acquire the shareholder and regain control. This acquisition, known as a management buy-out, requires obtaining debt funding to prevent additional owners from participating in the firm and ensure complete ownership. This approach appears to be the most effective way for Carlton to achieve his objective of securing funding for Miller's compensation and gaining full control. However, if Carlton is willing to give up some of his ownership, there are other options available.

One possible option for financing the buy-out of Miller is through debt in the form of convertible warrants. This would give control of the warrant holders in the company based on their investment amount and conversion timing. Another approach is to make the company public through an IPO, which would not only provide funds for the transaction but also serve as a future financing source for Carlton. However, the feasibility of this option is uncertain given that Carlton is a small company, despite its historically higher growth rate compared to the industry and stable margins.

The appeal of Carlton's stock to investors may be

questionable due to the likelihood that dividends will not be paid out, as evidenced by past behavior. Additionally, the high salary of the director will result in a lower return on equity for investors. In conclusion, while this approach would allow Carlton to eliminate Miller, it would not grant them complete control. Another possibility for removing Miller is to allow a different buyer, such as a strategic buyer, to acquire the company.

This paragraph discusses the different financing options available for a company like Carlton. One possibility is that another company may want to acquire a share in Carlton in order to utilize their distribution channel or factory. In such a case, control of Carlton will likely be given to the shareholders who acquire Miller's portion. Another option, private equity financing, is not feasible for Carlton because it typically involves taking over a struggling company and improving its performance with new management. However, Carlton is already performing well in terms of growth and sales. Financing through venture capital is also not possible as they typically fund start-up companies with innovative technology or services, requiring extensive monitoring and control from the VC. Finally, crowdfunding or business angel financing is not suitable for Carlton as they are not a start-up and the purpose of the funding is to buy out the other shareholder.