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.

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 Y

ear 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

Appendix B - Special Project Information ($ millions) Term of the Agreement (Years) 5.00 Initial Capital Expenditure for equipment $6.25 Expected Annual EBIT Contribution $2.00 Expected Annual Sales $7.50 Expected Annual Operating Expenses (including Depreciation of $1.25) $5.50 Expected Salvage Value of equipment $0.00

Poly Incorporated - Appendix C Balance Sheet for the Year Ending December 31 2019 ASSETS Current Assets Cash 2,250,000 Accounts Receivable 5,250,000 Inventory 8,125,000 Total Current Assets 15,625,000 PPE Equipment 9,375,000 Property and Plant 5,000,000 Total PP&E 14,375,000 TOTAL ASSETS 30,000,000 LIABILITIES Current Liabilities Accounts Payable 4,375,000 Accruals 1,875,000 Total Current Liabilities 6,250,000 Long-Term Debt Bank Loan 5,000,000 Total Long-Term Debt 5,000,000 Total Liabilities 11,250,000 Equity Common Stock 2,500,000 Retained Earnings 16,250,000 Total Equity 18,750,000 TOTAL LIABILITIES & EQUITY 30,000,000

Income Statement for the Year Ending December 31 2019

Sales 31,250,000 Cost of Goods Sold 21,875,000

Gross Profit 9,375,000

Selling, General & Admin 2,229,168

Depreciation 1,437,500

Earnings Before Interest & Taxes 5,708,333

Interest 500,000

Earnings Before Taxes 5,208,333

Income Tax @ 40% 2,083,333

NET INCOME 3,125,000

Shares Outstanding 1,100,000

Earnings per Share 2.84

Dividends Paid 0

Market Price of One Share of Stock 36

Potential Funding Sources - Financial Terms (Appendix D) Common Stock Terms Price at which new stock could be issued $62 Underwriting Costs per Share $9 Mortgage Bond Total Amount Offered w/out Poly Pipe Purchase $8 mm Total Amount Offered w/ Poly Pipe Purchase $13 mm Interest Rate 9.00% Repayment of Principal per Year (% of Loan) 10.00% Total Term of Loan (years) 10 years Payments Annual Payment Date December 31 Convertible Bond Total Amount Offered $10 mm Interest Rate 8.63% Repayment of Principal per Year (% of Loan) none Total Term of Loan (years) 10 years Payments Annual Payment Date December 31 # of Shares per $1000 bond if converted 15.625 Preferred Stock Total Amount Offered w/out Poly Pipe Purchase $8 mm Total Amount Offered w/ Poly Pipe Purchase $13 mm Dividend Rate 9.38% Dividend Payments Annual Dividend Payment Date December 31 Par Value per Share $1,000 Callable after 15 years at price per share of $1,050 Number of Warrants per Preferred Stock Share 13 Strike Price of each Warrant ($ per Rondo share) $77.00 Bank Loan Total Amount Offered w/out Poly Pipe Purchase $10 mm Interest Rate 11.50% Principal Payments per Year $2 mm Principal Repayment Begins 2020 Payments Annual Payment Date December 31

QUESTION 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.

QUESTION: Value Rondos existing mortgage bond. Summarize your analysis in an Executive Summary.