Question

William Mays and Randy Vicenti are the two equal shareholders of Square Dog, Inc. William is both an avid boater and king of the grill. The combination proved to be very frustrating to William because the kids’ hot dogs kept rolling off the grill on his houseboat when waves rocked the boat. William investigated alternatives and quickly realized that the solution would be a square hot dog. It was very expensive to make square hot dogs using existing technology. William approached Randy, his next-door neighbor, who is an engineer, and together the two of them created a new technology that makes square hot dogs for the same cost as regular ones.

Randy and William incorporated their business to have a structure for the production and sale of the Square Dog. They only expected the Square Dog to be a novelty item with limited sales potential. Sales have surprised them by growing very quickly. The company needs to add another production line to keep up with demand. Randy and William are considering different ways to raise money for the expansion of the company’s operations. All the initial funding for the company came from William and Randy when they bought their shares of stock. They know that one way to raise cash is to borrow money, but no bank is willing to loan them the required $10 Million. One banker suggested that they consider issuing more stock or bonds. They do not know what the advantages and disadvantages are of issuing bonds versus issuing common stock, and have no idea how to proceed.

Required: Prepare a memorandum addressed to William and Randy that addresses their issue. Use full paragraphs, not bullet points. You should use proper spelling and grammar. The target length is 500 words (about two pages double-spaced). Your memorandum should include the following headings:

Facts:

Issue:

Recommendation:

Discussion:

Conclusion: [Note your conclusion needs to match your recommendation]

Answer 1

Facts   

William Mays and Randy Vicenti have come up with an innovative idea of selling square hot dogs which have high sales potential as compared to expectations. In order to cater to the high demand they have to add another production line at a cost of $ 10 million. However in the absence of bank finance they are left with 2 options shares or bonds.

Issue   

The choice in front of them is between equity financing and debt financing. Their product inovation is their unique selling point. The decision to issue stock or bond is based on this improtant aspect of their buusiness. Bond being a debt instrument carries an interest burden which has to be paid. This will increase the risk of the business which is still new. Hence the best available course of financing is equity. The innovativeness of their product and its high sales potential should be properly highlighted to the potential investors. This will help the company get a good response to its public issue. However there is another issue to be considered which is dilution of owners equity. This should be considered at the time of the issue.

Recommendation

Considering all the facts and circumstances of the case, I would reccomend an equity issue.

Discussion

An equity issue will bring in the necessary cash required for the expansion of the business while at the same time keep th business debt free. This will put the company in a financially sound position. The product innovation and the high present and future sales potential will be a long term advantage for the company and the investors. Bonds would have been a viable alternative but for the fact that it will put a substantial interest burden which increases the leverage and hence the business risk. Business risk would have proved to be a hurdle for future equity financing.

Conclusion

Considering all the above factors it can be concluded that apart from the issue of owner's equity dilution Equity financing is the best available alternative.