Background

Coffee Limited is a catering private equity company that owns a chain of cafeterias in the UK. The company started experiencing a decline in its sales due to the current downturn of the economy. As a result its board of directors is examining the possibility of a strategic move into a new business concept in an attempt to diversify into a quick revenue type of business to recover the sales volume decline of the company.

The new concept involves the creation of a new chain of small quick take-away shops. This involves the creation of small take-away outlets selling coffee, drinks and snacks. The new shops will be based on the concept of selling all drinks for 1.00 and all snacks for 0.50. Snacks such as cheese pies, sausage pies, olive pies etc will be of a smaller size than those currently offered in the market. This will address two main market segments: Those who because of the economic downturn wish to spend less on buying a mid-morning or an afternoon snack and those who wish to buy something light either for health or diet reasons. The board of directors of Coffee Limited had met to discuss the opportunity to create a section within the company by developing the project. The project initially will involve the simultaneous opening of 15 outlets around the UK. All outlets will be having a common design and size so a standard fitted outlet will be produced by a subcontractor at a cost of 90,000 each (including all furniture, equipment and decoration). A 10,000 initial working capital per outlet is expected to be needed at the opening.

Finances

Currently the Statement of Financial Position of Coffee Limited is shown in exhibit 1. The long-term capital position of the company needs to be strengthened for two reasons:

1. To allow for the company to generate a cash inflow through the issue of new shares to its existing shareholders.
2. To be able to borrow from its bank on a sound leverage basis to secure low cost of borrowed funding and therefore to be able to finance the new project.

Coffee Limited

Statement of Financial Position

As at 31 December 2020

Land	500,000
Buildings (net book value)	1,000,000
Cash and Short Term Deposits	250,000
10% 20 year Loan Stock	250,000
Net Assets	2,000,000
1.5m Ordinary Shares	1,500,000
Profit and Loss Reserve	500,000
Equity	2,000,000

Exhibit 1: Statement of Financial Position, Coffee limited, 31 Dec. 2020.

Based on its estimates the company needs to raise a cash inflow of 1.5m.

The board of directors has decided to adopt the strategy summarized in the following business model, which is presented to the bank to agree it for the banks own contribution to raise the required funds to finance the proposed project proposal¹.

Business Model

The proposed business model involves the following steps:

1. To proceed with a 1 for 3 share bonus issue to be financed in full by using the Profit and loss reserve.
2. Following step 1, to proceed on a 1 for 4 share issue at a premium of 0.50cents
3. To revalue the buildings of the company² which on the basis of a professional property valuation report that has been obtained, today has a current market value of 1.75m.
4. It is estimated that the new balance sheet structure, will enable the company to obtain a long-term loan from the bank of 0.75m at an annual interest rate of 4.25% which is required to raise the total amount of 1.5m to finance the project.

If the procedure is followed on a timely basis it is expected that the project will be completed within a period of 3 months which will allow for the opening on 15 March 2022.

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¹The proposal is presented to the bank since it needs to be agreed before the company will proceed with its enforcement.

²The buildings are owned by the business for a period of 10 years and despite the recent negative changes in the property market the current market values still is well above the NBV.

Questions

Question 1 (70 marks)

Prepare the step by step equity structure of Coffee Limited, indicating at every step the amount of cash in-flow generated for the company.

Question 2 (30 marks)

Given the final equity structure of Coffee Limited, comment on its ability to borrow the proposed long term 0.75m from the Bank.