The Rondo Company (Context: Assume that your point of view is that of the CFO of Rondo analyzing its strategies on January 1 of the current calendar year.)

The Rondo Company is a medium size manufacturing company that manufactures copper, steel, and iron pipe. The company was founded by Bill Rondo, the current president and board chairman. Mr. Rondo owns the majority of the companys outstanding stock. The stock is publicly traded. Key financial, ownership and market information on Rondo is included in Appendix A.

In addition to the normal course of business, Rondo has two interesting opportunities that it is considering.

The first opportunity is a special contract with a long-time customer. The customer wants to enter into a five-year agreement to have Rondo produce a new type of pipe. Key expected financial information on this special project is included in Appendix B. In order to take advantage of the project, Rondo would have to invest the amount noted in Appendix B in special purpose equipment. It is unlikely that the contract would be renewed and also unlikely that the new equipment could be adapted to other production. Since the equipment would be special purpose, the expected salvage value is zero.

The second opportunity is the possibility of acquiring a company that makes PVC pipe. This company, Poly Pipe Incorporated (Poly), is smaller than Rondo. It had been started by several previous Rondo managers to take advantage of the new poly vinyl chloride pipe making technology. Although both companies are in the pipe business, their customer bases do not overlap significantly. Metal pipe and PVC pipe are used in different applications. Poly is publicly traded. The market is not active. The majority of the stock is still owned by the three founders. The remainder of the stock is owned by several hundred stockholders; its ownership is not concentrated. Key financial, market and ownership information on Poly Pipe Inc. is included in Appendix C. In addition to these opportunities, Rondo continues its modest growth. While the companys growth rate has varied over the last 10 years, it currently expects this historical growth rate to continue. However, Rondo is operating near its capacity. As a practical matter, growth will require incremental additions to production equipment.

Rondos Board of Directors has established several policies. While the Board prefers that these policies be followed, they would modify the policies if it made sense for the company.

The dividend payout ratio should be between 40% and 50%. The debt to total assets ratio should not be higher than 50%. Annual company growth should continue in the 5% to 10% range. The board will measure growth as the annual increase in Earnings Per Share. The company should maintain flexibility in financial transactions. No high risk transactions should be used, nor should the company tie its hands with financial arrangements.

In addition, Mr. Rondo wants to maintain his family ownership in the company at a minimum of 30%. He does not want to be required to purchase any additional stock. Since the Rondo family counts on the dividend payments, he is also adamant about continuing the dividend payments near their current per share rate.

Potential Poly Pipe Incorporated Purchase Poly is a small company that manufactures PVC pipe. They have been in business for 10 years. Growth has been relatively consistent for the last five years. Polys products do not compete directly with Rondos.

Polys managers want to sell the company. If the sale is to be a cash sale they will require a premium of 50% above the current market price to cover taxes and still leave a profit. They would be willing to sell by exchanging shares with an appropriate company, possibly on more favorable terms.

Potential Sources of Funds The company has investigated several sources of funding for the new project and for future needs. Detailed information and terms on each potential funding source is provided in Appendix D. Terms are those required by the provider of funds. While some conditions may be negotiable, most are cast in stone. The potential funding options are summarized below:

Common Stock New common stock could be issued at the current market price, however, underwriting and other associated costs (noted in Appendix D) must be considered in calculating the total proceeds that Rondo would receive.

Mortgage Bond The ABC Insurance Company, the company that provided the original mortgage bond, is willing to refund it. The current bond would be replaced with a new one, on the terms noted in Appendix D. The loan would be secured by all the assets of Rondo, including any assets acquired in the future.

Convertible Bond The XYZ Insurance Company is willing to issue a convertible bond. XYZ wants to be able to share in Rondos success but also retain the ability to remain a creditor if the Company is not successful. Each $1,000 bond would be convertible into a certain number of shares of Rondo common stock, as noted in Appendix D. In addition, cash dividends would be restricted. Cash dividends could not be paid unless net income was 20% of the value of the bonds outstanding.

Preferred Stock The MNO Insurance Company is willing to offer a preferred stock arrangement. In addition to the preferred stock, MNO wants warrants to sweeten the deal. Each share of preferred stock would contain warrants that allowed the purchase of a certain number of shares of Rondo Common stock at the exercise price outlined in Appendix D. In addition, if four consecutive dividends were missed, the preferred stockholders would elect 50% of the board of directors.

Bank Loan The current bank loan could be extended with additional amounts available, as noted in Appendix D. Note: for simplicity this case assumes that all interest payments on loans, bonds, and preferred stock are paid annually. You should know that bank loans have a wide variety of interest-payment arrangements, virtually all bonds have semiannual interest payments and preferred stock dividends are generally paid quarterly. Key Study Questions Throughout the course you will be asked to address the following issues: How is Rondo doing at this point in time? What are Rondos financing needs for the next 6 years? Is the new project a good deal? Why or why not? Are funds available internally? Are there any Board of Directors policies that you would suggest be changed? Why? Which financing source should be used to finance the new project and the companys continuing growth? Should Rondo purchase Poly? What should the offer be?

RONDO CASE - APPENDIX A BALANCE SHEET (as of 12/31) 2017 2018 2019 ASSETS Current Assets Cash 1,469,000 2,032,500 2,460,000 Accounts Receivable 9,000,000 9,375,000 9,750,000 Inventory 4,125,000 4,625,000 5,250,000 Total Current Assets 14,594,000 16,032,500 17,460,000

PPE Equipment 19,000,000 18,375,000 17,500,000 Property and Plant 16,000,000 15,375,000 14,750,000 Total PP&E 35,000,000 33,750,000 32,250,000 TOTAL ASSETS 49,594,000 49,782,500 49,710,000

LIABILITIES Current Liabilities Accounts Payable 1,500,000 2,250,000 2,500,000 Current Portion of Bank Loan 2,500,000 2,500,000 2,500,000 Accruals 3,375,000 3,500,000 3,750,000 Total Current Liabilities 7,375,000 8,250,000 8,750,000 Long-Term Debt Bank Loan 10,000,000 7,500,000 5,000,000 Mortgage Bond 5,000,000 5,000,000 5,000,000 Total Long-Term Debt 15,000,000 12,500,000 10,000,000 Total Liabilities 22,375,000 20,750,000 18,750,000 Equity Common Stock 9,587,500 9,587,500 9,587,500 Retained Earnings 17,631,500 19,445,000 21,372,500 Total Equity 27,219,000 29,032,500 30,960,000 TOTAL LIABILITIES & EQUITY 49,594,000 49,782,500 49,710,000 Notes to Rondo's Balance Sheet: Bank Loan Information Original Amount Borrowed 15,000,000 Amount Outstanding Dec 31, 2019 7,500,000 Interest Rate 6.00% Principal Payment Amt per Year 2,500,000 Year of Final Payment 2022 Interest & Principal Pmts Due December 31 Mortgage Bond Information Original Amount Borrowed 5,000,000 Amount Outstanding Dec 31, 2019 5,000,000 Coupon Interest Rate 7.50% Principal Payment Amt per Year 500,000 Principal Payments Begin in Year 2024 Year of Final Payment 2033 Interest and Principal Pmts Due December 31

INCOME STATEMENT (for year ending 12/31) 2017 2018 2019 Sales 41,250,000 46,250,000 50,000,000 Cost of Goods Sold (28,875,000) (32,375,000) (35,000,000) Gross Profit 12,375,000 13,875,000 15,000,000 Selling, General & Admin (4,560,000) (5,205,000) (5,850,000) Depreciation (1,500,000) (1,500,000) (1,750,000) Earnings Before Interest & Taxes 6,315,000 7,170,000 7,400,000 Interest (1,275,000) (1,125,000) (975,000) Earnings Before Taxes 5,040,000 6,045,000 6,425,000 Income Tax @ 40% (2,016,000) (2,418,000) (2,570,000) NET INCOME 3,024,000 3,627,000 3,855,000 Shares Outstanding 1,000,000 1,000,000 1,000,000 Earnings per Share 3.02 3.63 3.86 Dividends Paid 1,512,000 1,813,500 1,927,500 Increase in Retained Earnings 1,512,000 1,813,500 1,927,500 Market Price Per Share 62 Mr. Rondo's Share Ownership 60.00% Rondo Company Beta 1.20

Rondo 1 Prepare a three-year financial analysis of the Rondo Company based on the three years of Income Statement and Balance Sheet information provided in the case. Include (i) common size financial statements, (ii) key ratio analysis, (iii) trend analysis, and (iv) benchmarking analysis (identify a comparable industry to Rondo and compare Rondos key ratios to the industry ratios). Summarize your analysis in an Executive Summary.

Rondo 2 Value Rondos existing mortgage bond. Summarize your analysis in an Executive Summary.

Rondo 3 Prepare a financial forecast for the Rondo Company, including the computation of additional funds needed (AFN), for each of the next six years. Prepare the forecast income statements and balance sheets; identify potential ways to internally finance AFN. Provide an Executive Summary that presents your assumptions and your analysis of the financial forecast.

Rondo 4 Calculate the required rate of return on Rondos common stock using the CAPM model. Provide an executive summary discussing the implications.

Rondo 5 Calculate (i) Rondos dividend payout ratio, and (ii) the related dividend yield.

Rondo 6 Prepare a schedule calculating Rondos Weighted Average Cost of Capital as of its latest balance sheet date. Provide an executive summary analyzing your WACC calculation.

Rondo 7 Prepare an analysis of Rondo's proposed special project. This does not include the potential merger with Poly Pipe. Please show your cash flow analysis and the four capital budgeting methods discussed in class. Provide an executive summary presenting your analysis and recommendation.

Rondo 8 Assess the financing proposals in terms of attractiveness in cost and associated risk. Please evaluate the following financing alternatives: bank loan, mortgage bond, common stock, preferred stock with warrants and convertible bond. Your analysis should consider qualitative and quantitative issues. Which financing option do you recommend for Rondo and why? Provide an executive summary analyzing your results, and make a recommendation.

Rondo 9 Calculate the theoretical price for Rondos common stock using the Gordon Dividend Constant Growth Stock Model. Provide an executive summary discussing the implications of the valuation.

Rondo 10 Analyze whether Rondo should merge with its target company (Poly) and what offer should be made. Prepare a valuation of Poly using at least two valuation methods discussed in class in your analysis. Provide an executive summary analyzing your results and make a recommendation.