Final Exam

Finance Intensive Week Winter 2013

Submitted by: Jaydeep Parmar

Case: Fiesta Cards Ltd.
Part A: Qualitative analysis of the company
Fiesta Cards Ltd. is growing rapidly but facing financing problems
to support its growth. Fiesta Cards Ltd., was founded by Mr. Carl
Van Halderen in 1992 and is growing quickly. In 1999 it went
public through stock offering at $3 per share. Currently its shares
are traded at ~$6. It needs financial support to sustain rapid
growth.
Fiestas present debt to book value ratio is 3.14 (1999) and bank
loan to account receivable ratio is 0.87. So bank is nervous to
finance any more unless these ratios are under control. Bank feels
that Fiesta needs to raise more capital in order to get more
finance for growth.
Decisions that must be made:
1.
2.
3.
4.

Keep growing at present rate or slow down?

Envelop Machine should be purchased or not?
Humour Design Acquisition and
New Equity Finance from West Cost

Company must meet banks requirements which are as follows:

- Maximum bank loan out-standing at any time could not
exceed 80% of Fiestas Account receivables
- Fiestas total debt could not exceed three times the book
value

Available alternatives:
1. Slow down growth:
Disadvantages: Very difficult to regain lost customers whose
increased orders were turned down, demoralize salesmen
and may cause valuable salesmen to leave company. Market
share loss, Reduced company value
2. Continue growth through:
Additional equity capital:
Advantages: Reduce debt-to-equity ratio, Meets bank
requirements for financing, Boost morale of sales staff,
Customer retention
Disadvantages: Loss of control for Owner of major
shareholder. (Mr. Halderen) , Share value dilution.
Acquire Humour Designs:
Advantages: Higher margin, increase sales volume by 10%,
Purchase through so no debt to be incurred
Disadvantage: Increased debt level, share price may drop
further, owner control reduces even more.
New Equity Finance through West Coast Group:
Advantages: Reduce debt to equity ratio which will allow for
future financing needs, reduced cost of interest.
Disadvantages: Share value dilution, reduce degree of
control for owner.

3. Purchase envelop machine

Advantages: Reduce COGS and overheads, Increased
profitability, Less dependency on supplier, Short Payback
period
Disadvantages: Reduced debt-to-equity ratio, may exceed
bank allowance for credit

In order to evaluate each alternative we need to perform

financial analysis which reflects the changes in debt to
equity ratio, how much new equity is required to confirm to
banks requirements, effects of financing on ROE, share
value and control of owner (Mr.H) on company. We also need
to find out NPV of Envelop machine to see if its purchase is
worthwhile or not.

Part C: Recommendations and Justifications:

1. Continue growth: Slowing down growth is not a very
good option as it is going to affect adversely to Fiesta. If they
slow down now there will be many customers who will be
dissatisfied and probably never return back. Also there is a
major risk of losing best salesmen and demoralizing sales
staff. While company is growing at a 43% rate it is not very
wise to slow it down now and just because of financial
problems.
Raising equity through stock offer is not a best alternative to
use at present as Fiestas shares are not performing very
well. Also cost of raising capital this way will be very high

and uncertainty will exist as to enough capital can be

generated or not.
2. Acquire Humour Design: Acquiring Humour Design will
result in reduced bank loan to account receivable ratio. As
shown in calculations if we do so this ratio is 0.69, 0.66 and
0.56 for year 2000, 2001 and 2002, as compared to 0.87 in
1999. Also Total debt to book value for same period is
reduced from 3.14 in 1999 to 1.67, 1.38 and 1.04 which is
comparable to banks requirement. These are very positive
numbers and will also support any future financial needs.
Another good this about this acquisition is that we do not
have to use any cash but issue shares. Also this will add to
our profit margin and sales will increase by 10%. The only
down side is that owners control will be reduced.

3. New Equity Finance through West Coast group: This

alternative has both advantages and disadvantages of its
own. The cost of raising finance is low and interest costs will
be reduced as well over next few years. But it does not allow
bank loan to account ratio to stay under 0.8. In year 2001
and 2002 this ratio is 1.48 and 1.21, if we employ this
alternative which is way more than what is bank is asking
for. So we cannot use this alternative.

4. Purchase of Envelop Machine: Purchase of Envelop

machine is strongly recommended as it creates value for
Fiesta. Its pay-back period is only 2 years and NPV is $1.83
Million. IRR is also very high at 57%. It improves company
ROE by 2%. Also this purchase helps in improving bank loan
to account receivable ratio. ( Before purchase it is 3.69, 2.30
and 1.53 which goes down to 3.37, 2.14 and 1.44 in year
2000, 2001 and 2002 respectively)

In conclusion, if we purchase envelop machine and

acquire Humour Designs, we should be able to meet
all our financial needs and also meet banks
requirements to support growth. Money invested in
Envelop machine will be available back in 2 years and
bank will support any short term finance. Also if
company does good as a result of these efforts its
share price will improve in future, when we can raise
capital through stock offering if needed.