Question

QUESTION ONE

Carson Company is a large manufacturing firm in Accra that was created 20 years ago by the Carson family. It was
initially financed with an equity investment by the Carson family and 10 other individuals. Over time, Carson Company
has obtained substantial loans from finance companies and commercial banks.
The interest rate on the loans is tied to the
market interest rate and is adjusted every six months. Thus, Carson’s cost of obtaining funds is sensitive to interest rate
movements. It has a credit line with a bank in case it suddenly needs additional funds for a temporary period. It has
purchased Treasury securities that it could sell if it experiences any liquidity problems.

Carson Company has assets valued at about 50 million cedis and generates sales of about 100 million cedis per year. Some
of its growth is attributed to its acquisitions of other firms. Because of its expectations of a strong Ghanaian economy,
Carson Company plans to grow in the future by expanding its business by making more acquisitions. It expects that it will
need substantial long-term financing and plans to borrow additional funds either through loans or by issuing bonds. It is
also considering issuing stocks to raise funds in the next year. Carson closely monitors conditions in financial markets
that could affect its cash inflows and cash outflows and thereby affect its value.

i. In what way(s) is Carson a surplus unit? (2marks)

ii. In what way(s) is Carson a deficit unit? (2marks)

iii. How might finance companies facilitate Carson’s expansion? (4marks)

iv. How might commercial banks facilitate Carson’s expansion? (4marks)

v. Why might Carson have limited access to additional debt financing during its growth phase?

vi. How might Carson use the primary market to facilitate its expansion? (2marks)

vii. How can Carson use the secondary market?

viii. Explain why Carson would be interested in future interest rate movements? (2marks)

NB: Each explanation should not exceed 200 words

Answer 1

(i) Surplus unit is that firm which spends less than what they earn. In this case the company Carson has huge expansion plans and their existing earnings do not seem to be sufficient to address that. So this is not surplus unit.

(ii) Deficit unit means a firm spends more than what it earns. Carson is a deficit unit because they need to borrow funds in order to finance their expansion needs and plans.

(iii) Financial companies need to lend them money to meet immediate needs with as little paperworks as possible and might offer them a grace period initially of three or six months before they start paying the installments.

(iv) Also the credit line they have with banks can fulfill the needs to address working capital gap when needed. Banks can offer them lower interest rates and reschedule their payments when the company pays them partly. They can also partner with the company and become an investor is the expansion plan is valid and feasible.

(v) Additional access to funds is required for expansion needs. They are acquiring firms and need money for market expansion and penetration as well in order to capitalize the growing economy.

(vi) The company can launch IPOs to raise funds immediately without liabilities of interest payments

(vii) The secondary market offers investors a possibility to gain capital via trading in future. So they will invest if the company split their stocks and lowers the prices, in hope of gaining more in future.

viii) Carson would expect interest rates to go down so that borrowing cost decreases.