Question

This assignment is discussion only.  For each question, provide an answer and a brief justification or explanation of your answer.

Base your answers ONLY on the information provided in the question.

1. The accounting firm Price-Waterhouse Coopers provides tax and consulting services.  Kroger is one of the largest grocery chains in the US. Assume that neither firm is substantially affected by the business cycle and that both firms are profitable.  Which of these two companies do you think has greater debt capacity (please explain)?

2. Tesla Motors is a relatively young firm in a mature industry.  The auto industry is capital/asset intensive, utilizing production equipment that is tangible and is useful to other firms. Unlike other car firms, Tesla is growing at a rapid pace such that the value of this growth is not reflected in Tesla’s balance sheet.  Also, Tesla has yet to generate an operating profit (positive EBIT).  However, like all car companies, Tesla’s sales are subject to variation due to fluctuations in the business cycle where consumers are more likely to purchase a car when the economy is strong and less likely during a weak economy.   Relative to Ford, GM, and its other competitors, should Tesla finance its operations with relatively more debt (and less equity) or more equity and less debt (justify your answer)?

3. Interest rates are currently low, but many analysts believe that they will rise over the next couple of years. You are consulting the management of a local firm that needs to borrow to finance its growth.  They would like your advice on the type of debt and maturity of debt that they should use.  Should this firm issue short-term or long-term debt, and should this debt be issued at a fixed coupon rate or a variable/floating rate (provide an explanation for your answer)?

Answer 1

Kroger would have better debt capacity.

As its a grocery chain, their volume of sales and steady cashflow would be far greater than PwC. Tax and consultancy firms would get revenues on a quarterly, semi-annually or yearly basis from clients and tax specifically works in cycles so there isnt steady in-flow on the day-to-day. Also, clients may delay payments due to business reasons which could impact their debt taking capacity. While kroger services every day consumers who dont really get any credit facility in terms of payments imply very little presence of a credit receipt cycle which again positively impacts their debt taking capacity.