Case Study - Humber Sports Inc. (HSI)
Humber Sports Inc., a successful Canadian retailer has no debt outstanding and a total market value of $90, 000. For the period ending December 31, 2013, they projected the net income before taxes will be $15, 000.
Humber Sports Inc. is evaluating a $45, 000 debt issuance (unsecured) with a 5% contract interest rate and maturing in 2018. They currently have 4, 500 shares outstanding. The Board of Directors has authorized 20,000 shares. The new debt issuance will be used to repurchase 50% their existing shares. Tax rate: 35%
1) Complete the Following Journal Entries
- Prepare the January 1, 2014 journal entry to record issuance of the new debt.
- Calculate and prepare the June 30, 2014 journal entry to record the first interest payment.
- Prepare the journal entry for the retirement of debt for December 31, 2018
2) Calculations and Analysis: Complete the Chart by completing the following calculations (No Dividends, No Depreciation)
A) Current Structure: (7 Calculations required)
- Ensure you calculate current: number of shares outstanding, taxes, NIAT, E.P.S. and R.O.E.
B) New Proposed Structure:
- Calculate the change in net income before tax (NIBT)
- Calculate Net Income after change in capital structure (NIAT)
- Calculate how many shares can HSI repurchase and show new total market equity value
- Calculate earnings per share EPS) after debt issuance (assuming no dividend).
- Calculate the return on equity (R.O.E). after debt issuance (assuming no dividend).
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Current
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Proposed New Structure
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Change
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Net Income Before Interest and TAX
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Interest Expense
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Net Income Before Tax (NIBT)
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Tax (tax rate 35%)
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Net Income after Tax (NIAT)
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E.P.S.
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Debt Ratio
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R.O.E.
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3) Short Answers, Analysis and Critical Thinking
- What type of Bond is HSI considering -- describe at least 2 types as per information provided in the case.
- Would the proposed debt issuance be considered debenture? Why/Why not explain
- List the players involved in the process of issuing debt and the roles they play.
- Compare the advantages and disadvantages of bond financing.
- In a tax environment what is the impact of the capital restructure as a result of the new debt? List at least 2 additional types of impact (financial or otherwise) as a result of the new debt issuance.
- As a current shareholder would you be in support of the new debt issuance? Why/Why not, fully explain
- Discuss the journal entries required to record the issuance of the bond when issued at par vs at premium
- Discuss the retirement of bonds (include the steps involved for the issuer and bondholder.
- Did HSI achieve financial leverage? Explain Why or Why Not?
- Comment on the change in Debt ratio and R. O. E.