Problem
Overview
Huy Publications Ltd. (HPL) operates in the highly competitive printing business, a sector known for its high rate of business failures. While HPL has had some rough financial years in the past, it now owns state-of-the-art printing facilities-financed through government-guaranteed debt-that have stabilized the company's position. HPL is controlled by Jack Huy and his two sons, but there are several other shareholders who were brought into the company when additional share capital was necessary for survival. In March 20X2, HPL completed negotiations for a 10-year, $14,600,000 loan. Senior management was meeting to evaluate the three alternatives:
I. A 10-year $14,600,000 long-term loan from the Canadian Bank. The loan has the following terms: a. The interest rate is 8.2%, compounded annually. The interest rate is fixed for the life of the loan and is paid at the end of each year. b. Principal is to be repaid in one lump sum at the end of 10 years. c. The bank will charge a $19,000 upfront administrative fee. d. HPL will be required to move all banking activities of the company to the Canadian Bank (from the Ottawa Bank, its current financial institution.) This will cost HPL $5,500 in fees, either at Canadian or Ottawa. e. HPL will agree to a maximum debt to equity ratio of 2-to-1 and pay no dividends in excess of 30% of reported earnings during the life of the loan. Ratios are based on audited financial statements. f. Loan security is a second mortgage on HPL's printing facilities and personal guarantees from the principal shareholders of HPL.
II. A 10-year $14,600,000 long-term loan from the Ottawa Bank. The loan has the following terms: a. The interest rate is 6.5%, compounded annually, for the first five years of the loan. The interest rate for the second five years is to be established at the beginning of the second five-year term based on prime interest rates at that time. Interest is due at the end of each year. b. The bank will charge a $110,000 upfront administration fee. c. HPL will agree to issue no new long-term debt over the life of the loan, without the express permission of Ottawa, and maintain dividend declarations to common shareholders at no more than current levels (approximately 10%-15% of earnings). d. The loan will be secured by a second mortgage on HPL's printing facilities and a floating charge on all corporate assets. e. Principal is due at the end of the loan term.
III. A 10-year, $14,600,000 bond payable from a pension fund. The bond has the following terms:
i. The interest rate is fixed at 8%, compounded semi-annually over the life of the bond. Interest is due every six months.
ii. The bond is secured by the general credit rating of HPL.
iii. HPL will agree to the following conditions:
a. The current ratio will not go lower than 3-to-1.
b. The debt to equity ratio will not exceed 2.5-to-1.
c. No dividends will be paid to common shareholders unless the current ratio is 3.5 to 1 after declaration. (All ratios are based on audited financial statements.)
d. No common shares will be issued or repurchased without the written permission of the lender. v. No changes to management will take place without informing the lender.
e. The lender will be given a seat on the HPL board of directors for the life of the bond. vii. The bond will involve $227,500 in legal and other costs at inception, to be paid by HPL
Task
Prepare case report outlining all 3 alternatives/financial reporting issues.