Current Financial Characteristics of CCI
The motor carrier industry is highly regulated, resulting with high level of financial stability. Through government regulations, more specifically from the U.S Interstate Commerce Commission (ICC), Continental Carriers and others have received steady financial resource allocations and maintained steadily increasing profits with minimal fluctuations over the years. In addition, with the government’s tight entry control, the industry is able to create a high market entry barrier to prevent new entrants from gaining market shares. On top of that, rate regulations have helped prevent destructive competitions within the industry. Traditionally, ...view middle of the document...
Potential Effects of Acquisition
Most companies acquire other firms with the motivation of enlarging market share, expanding company growth and increasing revenues as such action may present a positive signal to the investors. Such goals are achievable as long as there is suitable financing decision made. However, problem may appear after the acquisition is complete since there maybe difficulties in management or insufficiently analyzed financing method. As previously mentioned, CCI is a company experiencing steady growth within a regulated industry, meaning that the demand and cash flow are steady. Given that CCI is fully financed by equity now, acquiring Midland to expand route (Chicago to Michigan and Indiana) can be relatively riskless due to CCI’s strong financial ability. As long as proper financing decision is chosen to support such US$ 50 million acquisition expense, investors will view this acquisition as a positive signal as CCI keeps seeking growth and has the financial ability to sustain the growth. Therefore, stock price will rise, investors will receive more dividends, and with such cycle CCI can recover from the acquisition expense relatively quickly without risk. CCI may face potential risks and the most significant is the proper financial decision should be made to support such acquisition since any miscalculation or estimation may lead to company loss and endanger shareholder value. Secondly, there may be potential managerial dissonance. However, the chance of such problem occurring is relatively low because CCI and Midland are similar in core. In fact, Midland will just serve as an additional branch of CCI. Given that it is a regulated industry, the cash flow will less likely suffer from drastic fluctuation. Overall, the risks of CCI acquiring Midland are relatively low as long as CCI management selects the appropriate financing method.
The Pros and Cons of Using Common Stocks
Several disadvantages have been found related to the use of common stock for financing CCI’s acquisition. 1）First, unlike bonds interest which is tax deductible, CCI will have to pay tax for all the earnings before paying out dividends to shareholders. When corporate tax is taken into account, the firm value is positively related to its debt. As an example, from 1982 to 1988, a nearly 50% of income tax has been charged annually to CCI’s total earnings and this portion could have been reduced if the firm was financially levered. By computing the unlevered firm value, we have: Vu = EBIT (1-t) / Ksu = 34000 (.5)/0.069 = 246376.8116 (in thousand of dollars) where Ksu = cost of equity = 1.5 / 21.75 = 0.069 The unlevered firm value is less than that of levered firm which equals to: VL = Vu + tD = 246376.8116 + (40% of 5000) = 266376.8116
2) Secondly, stock dilution could be a potential problem. Stock dilution occurs when additional shares have been issued by a company and it could have negative effect on the stock price and EPS. Furthermore, it...