High Rock Industries is considering various financing options to raise $6 million to purchase new industrial property. The options are: issuing straight debentures at 7% interest over 15 years, issuing new equity, or issuing preferred stock at $100 par value yielding 8%. An analysis of the options' impact on financial ratios and profitability shows preferred stock issuance leads to the highest returns and financial flexibility going forward while maintaining manageable risk levels. Therefore, preferred stock is recommended as the best financing option.

1. HIGH ROCK INDUSTRIES CASE
Awa Traore, Bony Faliandri Hudi, Citra Rinanti TP. & Irwan Arfandi B.
Master of Management – Gadjah Mada University

2. Brief Summary
• High Rock Industries (HRI) was engaged in purchase of
underdeveloped acreage which was then developed for industrial
use.
• HRI considered the asking price of $6 million to be most reasonable
• Crawford’s financial staff assured her of an increase in HRI’s earnings
before interest and taxes (EBIT) of 20 percent

3. How to get 6 million?
• Debt: $6 millions of straight debentures, with a 7% coupon and a
15 year maturity. Flotation cost of $200.000. There was also the
possibility of a sinking fund of $400.000 per year, although all
parties thought this unlikely with regards to the existing level of
interest rates and the company’s reputation.
• Equity: An equity issue could be sold to the public.
• Preferred stock: One-hundred-dollars per share preferred stock
could be sold to net the company $93.50 per share after brokerage
fees. The yield on preferred stock of equivalent quality is 8 percent.

4. THEORETICAL BACKGROUND

5. Equity Financing
“ Equity financing is when you (the business owner) sell an ownership
interest in your business in exchange for money. The business owner
and the investor(s) shares the business and the risks that come with it”
• Advantages of Equity Financing
Cash flow that would have been used to repay the loan, can be used
to grow the business.
• Dis-Advantages of Equity Financing
Loss of interest of ownership of your business and also the possible
loss of complete control that can accompany a sharing of business
ownership with investors.

6. Debt financing
“Debt financing means taking out a loan (money that is to be paid
back over a certain period of time, usually with interest)”
Advantages of Debt Financing
• Lending party does not gain any part of ownership of your business
and your only obligation to lending party is to repay the debt
• Dis-Advantages of Debt Financing
The biggest dis-advantage is that the business will not have all of its
cash flow available to do business. Also, the interest that is owed can
be high

7. Investment Banker
• Most also maintain broker/dealer operations, maintain markets for
previously issued securities, and offer advisory services to investors
• Unlike traditional banks, investment banks do not accept deposits
from and provide loans to individuals

8. Debenture
• Long-term debt instrument used by governments and large
companies to obtain funds
• It is defined as quot;a debt secured only by the debtor’s earning power,
not by a lien on any specific asset
• It is similar to a bond except the securitization conditions are different

9. Sinking Fund and Flotation
Cost
• What Does Sinking Fund Mean?
A means of repaying funds that were borrowed through a bond issue.
The issuer makes periodic payments to a trustee who retires part of
the issue by purchasing the bonds in the open market
• What Does Flotation Cost Mean?
The costs associated with the issuance of new securities.
Flotation costs include both the underwriting spread and the costs
incurred by the issuing company from the offering

10. ANSWERING THE QUESTION

11. •Pattern is not a standard
•Give higher EBIT
FIT

12. HIGH ROCK INDUSTRIES OLD DEBT EQUITY PREFF STOCK
10.000.000 10.600.000 10.882.140 11.272.140
Revenue
5.589.300 5.589.300 5.589.300 5.589.300
Cost of sales
200.000 - -
Flotation cost
400.000 - -
Sinking cost
- - 390.000
Brokerage fees
4.410.700 5.292.840 5.292.840 5.292.840
EBIT
2.375.000 2.795.000 2.375.000 2.375.000
Interest
2.035.700 2.497.840 2.917.840 2.917.840
Taxable income
610.710 749.352 875.352 875.352
Taxes (30%)
1.424.990 1.748.488 2.042.488 2.042.488
Profit after tax

13. HIGH ROCK INDUSTRIES BALANCE SHEET: EQUITY
HIGH ROCK INDUSTRIES BALANCE SHEET DEBT
Current asset 7.500.000
Current asset
Net Fixed Asset 52.000.000
7.500.000
Total asset 59.500.000
Net Fixed Asset
52.000.000
Current Liabilties 500.000
Total asset
Long term debt 25.000.000
59.500.000
Common stock 26.000.000
Retained Earnings 8.000.000
Current Liabilties
Total liabilities and equity 59.500.000
500.000
Long term debt
31.000.000
HIGH ROCK INDUSTRIES BALANCE SHEET: PREF STOCK
Common stock ($20 par)
Current asset 7.110.000
20.000.000
Net Fixed Asset 52.000.000
Retained Earnings
Total asset 59.110.000
8.000.000
Total liabilities and equity
Current Liabilties 500.000
59.500.000
Long term debt 25.000.000
Common stock ($20) 20.000.000
Preffered Stock 5.610.000
($93.5)
Retained Earnings 8.000.000
Total liabilities and 59.110.000
equity

14. DEBT EQUITY PS
CURRENT RATIO 15,0000 15,0000 14,2200
TOTAL ASSET TURNOVER 0,1782 0,1829 0,1907
DEBT RATIO 0,5294 0,4286 0,4314
ROA 0,0294 0,0343 0,0346
ROE 0,0874 0,0786 0,1021
TIE 1,8937 2,2286 2,2286
DEBT TO EQUITY RATIO 1,1250 0,7500 0,7476
So, go for the preffered stock!

15. F = Flexibility Some common quot;otherquot; considerations are:
Asset structure
R = Risk Floatation costs
Speed
I = Income Management attitudes
Exposure
C = Control Market valuation
T = Timing
O = Other

16. Net income, Profitability ratio like ROA and ROE, and debt
management ratio like TIE and Debt ratio.

17. Debt/Total Asset TIE
OLD 0,4758 1,8571
DEBT 0,5180 1,8937
EQUITY 0,4197 2,2286
PREF STOCK 0,4229 2,2286

18. Because of the cash drain caused by sinking-fund requirements,
the financial manager might be concerned with the uncommitted
earnings per share related to each financing plan

19. Back to FRICTO
Speed
Management attitudes
Control

20. Probability estimate of the level of EBIT will be used to forecast
the income, and used to compare the benefit vs the cost of
alternatives

21. •Ranking of other firms bonds in the same
industry for comparison
•Market condition

22. •Ranking of other firms bonds in the same
industry for comparison
•Market condition

23. •New debt to asset: 31/59.5 = 52 %, which
is lower than 55
•Give them flexibility again

24. •Flexibility, refers to the future financing options for
management (Debt to Asset ratio)
•As capital is raised, the choice among alternatives for
raising capital in the future may be narrowed

25. •Risk and income are so interrelated they cannot be discussed
separately
• Higher risk demand higher return
To calculate the risk
Debt Ratio = Total Liabilities
Total Assets
Times Interest = EBIT
Earned (XIE) Interest Expense
Fixed Charge = EBIT + TDFC
Coverage Interest + TDFC
Debt Service = EBIT + DEP + TDFC + NTDFC
Coverage Interest + TDFC + NTDFC/(1-tx)
where:
TDFC = Tax deductible fixed charges other than interest (lease payments, etc.)
NTDFC = Non-tax deductible fixed charges (principal repayment, etc.)