Three proposals were put forward for further consideration after a meeting of the executive directors of Ennea Co to discuss the future investment and financing strategy of the business. Ennea Co is a listed company operating in the haulage and shipping industry.
Proposal 1
To increase the company’s level of debt by borrowing a further $20 million and use the funds raised to buy back share capital.
Proposal 2
To increase the company’s level of debt by borrowing a further $20 million and use these funds to invest in additional non-current assets in the haulage strategic business unit.
Proposal 3
To sell excess non-current haulage assets with a net book value of $25 million for $27 million and focus on offering more services to the shipping strategic business unit. This business unit will require no additional investment in non-current assets. All the funds raised from the sale of the non-current assets will be used to reduce the company’s debt.
Ennea Co financial information
Extracts from the forecast financial position for the coming year
Ennea Co’s forecast after tax profit for the coming year is expected to be $26 million and its current share price is $3·20 per share. The non-current liabilities consist solely of a 6% medium term loan redeemable within seven years. The terms of the loan contract stipulates that an increase in borrowing will result in an increase in the coupon payable of 25 basis points on the total amount borrowed, while a reduction in borrowing will lower the coupon payable by 15 basis points on the total amount borrowed.
Ennea Co’s effective tax rate is 20%. The company’s estimated after tax rate of return on investment is expected to be 15% on any new investment. It is expected that any reduction in investment would suffer the same rate of return.
Required:
(a) Estimate and discuss the impact of each of the three proposals on the forecast statement of financial position, the earnings and earnings per share, and gearing of Ennea Co. (20 marks)
(b) An alternative suggestion to proposal three was made where the non-current assets could be leased to other companies instead of being sold. The lease receipts would then be converted into an asset through securitisation. The proceeds from the sale of the securitised lease receipts asset would be used to reduce the outstanding loan borrowings.
Required:
Explain what the securitisation process would involve and what would be the key barriers to Ennea Co undertaking the process. (5 marks)