Pacific Grove Spice Company Case Analysis
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Based on the company’s forecasted financial statements, can the company quickly comply with the banks requirements? It depends on what you consider quickly. If the deadline is to only to have a plan ready by June 30th, 2012 then it looks like they can come pretty close without implementing any major change4s. Just by following their expected future growth plans they will almost reach the requirements of the bank within 4 years. Using the information provided from their forecasted financials, by 2015 Pacific Grove will reach q 55% ratio of interest/bearing debt to total assets and their equity multiplier will be 2.77. Depending on how stringent the bank is this may not be quick enough of a timeline or progressive enough of a plan. If they want these figures lowered to the required levels by 2012 then Pacific Grove must do something more aggressive reduce interest bearing debt levels.
The company should explore ways to reduce its need for working capital financing. They should see if there are ways of improving their supply chain efficiency and forecasting so that they can reduce their inventory levels. They should look to negotiate with suppliers to reduce the rate they are paying for inventory. Pacific Grove should also see if they can extend the length of their accounts payable. Even if they have to pay a slight price premium, if the rate (APR) is less than what the banks are charging them in interest, it could help to both save money and reduce their capital needs. They should also see if they can adjust the credit policy terms with their customers to shorten the number of days before payment.
By reducing receivables and increasing payables they should be able to reduce their debt within a year. Raising funds by selling common stock to pay-off some of their interest bearing debt may be necessary in order to quickly comply with the banks requirements. My suggestion however would be to acquire the other company which has better debt structure. When the two companies are financial are combined Pacific Groves rations will be under those required by the bank. Introduction
Pacific Grove Spice Company was opened in the early 1980’s as a small specialty grocer in California. In the late 1990’s the company hired Debra Peterson in the retail distribution sector of the company. She then moved into the position as the Chief Operating Officer. The company continued to grow and the founders did not want to actively manage the company any longer. The company appointed Peterson as the president and CEO of Pacific Grove Spice Company. The sales and profits continued to increase rapidly. Even though the company was profitable, retained earnings were not sufficient to fund the growing of assets. In 2011 the bank that the company does business with was not comfortable with the total amount of interest-bearing debt that Pacific Grove Spice Company had on their balance sheet.
The company was showing debt in access of $37 million. The bank informed the company that it wanted a plan of action to reduce the interest-bearing debt to fewer than 55% of total assets and they also wanted to see the equity multiplier down to less than 2.7 times by June 30, 2012. Pacific Coast needs to meet this requirement that the bank is giving them because they are refusing to lend additional credit to Pacific Grove unless this is met. Opportunities in the Case Study
A cooking network approached Pacific to sponsor and produce a half hour program with a young popular chef. There are negotiations with the TV network and a tentative agreement is in place. The company’s financial team analyzed the investments of this proposed deal. Another option Pacific has to finance their growth and reduce the company’s debt is to sell new common stock. Pacific Grove Spice Company’s common stock is traded on the NASDAQ and has a current stock price of $32.60. The founders of the company hold approximately 25% of the shares and Peterson owns about 7%. There is an investment group that is willing to purchase 400,000 shares.
The final option is a possible acquisition of High Country Seasonings, located in Colorado and founded in 1991. High Country Seasonings started as a local business but grew into a regional business. The two sisters that started the business want to sell 100% of their ownership. Negotiations between High Country and Pacific have been in progress and High Country wants $13.2 million. The sisters want a common stock only transfer to avoid taxes. They are requesting a total of: 404,908 shares of Pacific at $32.60 a share. Decisions for the Case Study
1. Should Pacific accept an offer from a cable cooking network to produce and sponsor a new program? This opportunity would increase the company’s sales, profits, and cash flow above the presented in Exhibit 1, but would require investment in television equipment, capacity and working capital. 2. Should Pacific raise new equity capital by selling shares of common stock? 3. Should Pacific acquire High Country Seasonings – a privately owned spice company with sales revenue approximately 22% of Pacific’s? Analysis of Options
Should Pacific accept an offer from a cable cooking network to produce and sponsor a new program? This opportunity would increase the company’s sales, profits, and cash flow above the presented in Exhibit 1, but would require investment in television equipment, capacity and working capital. Pacific is needing more funding for assets. This is to support their high growth in sales. Right now, their financing is provided by a bank that is concerned about the large interest bearing debt on their balance sheet. The company is looking at a cooking network to produce and sponsor a show this would provide good sales increasing at the rate of 5%. When I first looked at this option I thought it would be a good option for the company, however the investment would increase the company’s sales, profits, and cash flow but also increase their net working capital means and the project has negative cash flow for both year 0 and year 1.
Pacific needs a total of $2,573,118 to initially start this option before positive project cash flows start. When you only take into account the IRR and the NPV it is positive at 41.28% this option looks like a good investment. It is clear from Exhibit 3 that this project has the cash flow stream that is not sufficient to decrease the financial leverage of the Pacific that the bank is asking for. If you add the NPV of the project to the net worth of the company in 2011 it hardly changes the financial leverage of the company. If the WACC for Pacific was 20% the expected NPV of the project would be about $1,716,414. Taking the discounted payback into consideration a WACC of 20% the project payback period would be approximately 4 years. There is a large risk in this project not even taking into account the actual performance. The TV program could be a total flop.
Having a connection with a TV network could benefit Pacific’s brand with promotions however, Pacific lacks knowledge in the TV network industry. By moving forward with this project would put more interest bearing debt on the balance sheet. This project does allow for some good return, but it does not meet the financial requirements that the company needs to satisfy the bank. If the company really wanted to move forward with this option even though I personally do not think it is a good idea, they could gain capital and not increase debt by selling shares of the company. However, current shareholders may not like this option. Should Pacific raise new equity capital by selling shares of common stock?