In late 1992, two executives of Workman Tool, Inc., the largest privately owned corporation in Ohio, decided to start a company of their own. There were two primary reasons for their decision. First, both men had the entrepreneurial spirit and longed to have a shot at their own business. Second, Workmans ownership structure precluded managers from receiving stock options as part of their compensation package. Thus, although the firm was generous in its salaries and bonuses, everything was subject to immediate taxation. Both men thought that a new business would give them the opportunity to defer taxes on a large part of their overall compensation. The two men, Julio Rodriguez and Toby Fulton, found a medium-sized precision tool

company that was on the market. The company, Precision Tool Company, is wholly owned by its founder, Nick Sanders. Although the company is in sound condition, Sanders, who is in his late 40s, recently suffered a heart attack and was advised by his doctor to sell the firm and relaxor else. Sanders is asking $8,250,000 for the firm, which works out to a Price/Earnings ratio of approximately 9x, and he has given Rodriguez and Fulton a 6-month purchase option to allow the pair time to arrange financing. Rodriguez contacted Paul Van Buren, a partner in the New York City investment banking

firm of Aberwald, Butler, Van Buren & Company, to help arrange the needed financing. Rodriguez and Fulton each have some savings to put into the purchase, but they need a substantial amount of outside capital to complete the deal. Although the funds could probably be borrowed, Van Buren is not enthusiastic about this alternative. For one thing, Precision Tools debt ratio is currently at 30 percent, which is the industry average (see Table 1). Second, Rodriguez and Fulton envision using Precision Tool as a vehicle to acquire several smaller companies, and some reserve debt capacity would be needed if this strategy is pursued. Van Buren proposes that

the two partners obtain funds to purchase Precision Tool in

accordance with the schedule shown in Table 2. Precision Tool would be restructured with 6 million common shares authorized1,350,000 shares to be issued at the time of the sale and 4,650,000 shares to be held in reserve for future acquisitions. Rodriguez and Fulton would each purchase 180,000 shares at a price of $1 per share, the par value. Aberwald, Butler, Van Buren & Company would purchase 150,000 shares at a price of $8.50 and the remaining 840,000 shares would be sold to the public at the $8.50 price. The underwriting fee to Aberwald, Butler, Van Buren & Company would be 5 percent of the

proceeds from the public sale, or $357,000. Legal fees, accounting fees, and other charges would amount to $63,000, for total underwriting costs of $420,000. After deducting the underwriting charges and the payment to Sanders, the restructured Precision Tool would have an additional $105,000 in its cash account. Also as part of the agreement would be a provision which grants 1-year options to purchase additional shares. Rodriguez and Fulton could collectively purchase an additional 120,000 shares, while Parks, Van Buren & Company could purchase an additional 100,000 shares, all at $8.50.

A second financing alternative is also being considered, although Van Buren is less enthusiastic about this approach. Van Buren has made some preliminary inquiries to Silverman Sachs, a San Francisco investment-banking house which specializes in junk-bond financing. It looks like $6 million of high yield bonds could be sold to help finance the acquisition. However, these bonds would require a coupon rate of 18 percent. With the alternatives in mind, Rodriguez and Fulton must now make their financing decision. Van Buren believes that the financing could be obtained within ninety days once the decision is made. He also suggested that the partners develop some pro forma income statements for 1993, which reflect the impact of the two alternative financing plans. The partners believe that sales would grow by 10 percent under their leadership, and that cost of goods sold and general/administrative expenses would be about the same percentage of sales as in 1992. Lease and depreciation expenses would remain at their 1992 levels, while interest expense would be the 1992 level plus interest on any new debt percent. issued. The firms federal-plus-state tax rate is 40 percent.

TABLE1 Selected Financial Statements Balance Sheet as of December 31, 1992 Cash Accounts receivable $2,285,000 Inventories $ 380,000 1,150,000 315,000 S 1,845,000 S1639.000 $3.484.000 1,000,000 S 7,128.000 $8.128.000 $11612,000 $1,050,000 Accounts payable Notes payable Accruals Current assets Net fixed assets $1777,000 Current liabilities $5,112,000 Long-term debt $6,500,000 Total liabilities Capital stock Retained earnings Total equity Total assets $11612,000 Total capital Income Statement for the Year Ended December 31, 1992 Sales Cost of goods sold Gross margin General/administrative expenses Lease expense Depreciation EBIT Interest expense Earnings before taxe Taxes Net Income $12,850,000 7.251000 5,599,000 $1,769,000 600,000 $ 850,000 2,380,000 $850.000 $ 1,530,000 61 2.000