Question

1. CK Tech, a technology company, has had a 20% rate of growth for five consecutive years and has produced steady positive cash flows. The most recent economic and technology sector indicators show signs of slowing growth. CK Tech recently announced the issuance of bonds totaling 40% of the company’s current market cap.What would be a possible reason CK Tech has decided to raise capital this way? Explain why it is or is not an appropriate financing method for this organization?

Answer 1

From the given data, we can understand the following:

· CK Tech has had 20% positive growth rate during the 5 years tenure.

· The company issued 40% of bonds of total market cap, when there was a slowdown in the economic and technology sector.

Objective of the problem statement: To possibly reason out the decision of CK Tech to raise its capital by selling off the bonds and analyze the decision.

Bonds and its issuance:

Bonds are the fixed income instrument (represents as loan) which is made between two parties (usually an investor and the private or government body), where the investor gives out loan to the borrower for a certain period of time to enhance the capital funding of the body and in exchange receive periodic interest payments at the intervals. The bond details are the end date which is when the principal of the loan is due to be paid to the bond owner (investor) and the terms for interest payments are made by the borrower (corporate or government).

Bonds are issued when the companies or any government body need to raise money. Private bodies mainly use the bonds as to grow their business. Usually a bank may not be able to provide huge loans to corporates, hence bonds provide a quick fix by allowing investors to lend out liquidity to the corporates. Also, the interest rate of the bonds is comparatively less than the interest rate given by the bank. Hence, the issuance of the bonds is highly beneficial to both the corporate and government bodies for capital growth.

Given the scenario, CK Tech is issuing 40% of its market cap which is a huge share hold and thus can be a discouraging factor for the investors as the promoters have liquified their holdings.

The strategy put in by CK Tech to do so might be because the company wanted to attract more investors in order to add on to the growth of the organization and bring on more funds to increase their positive cash flows higher than 20%.

As per the justification given, it can be said that issuing 40% of its market cap is not an appropriate financing method since:

· The economic and technology indicators predict slow growth rate which means that the company may not have high productivity during that period even if bringing on more capitals. The demand on the sector side might be less so the company might be in loss or have a stagnant growth rate as per the data given in the question.

· CK Tech will have to pay back the debts on the maturity date, which is agreed with the bond owner, with the interest rate at specific intervals. The low production can take some time to recover in the market, which is quite uncertain. So, the debt can increase significantly and in the worst case the company might not be able to repay the entire amount at the time of bond maturity.