General Stuff is a food processing company that manufactures a wide variety of food products, including pasta, cereal, juice beverages, and confectionery goods. In addition to food processing, General Stuff has acquired a small, regional restaurant chain within the past year. The management of General Stuff believes that the most profitable course would be to expand the restaurant chain to become a major player in the national market. To do this, however, requires cash—which General Stuff doesn't have quite enough of right now. General Stuff's management has determined that it needs to raise $1 million in capital next year beyond the funds generated internally.
General Stuff had revenues of around $1.2 billion in the last fiscal year and revenues are expected to increase at a rate of 8% per year for the next five years if the restaurant chain is expanded as planned. The vast majority (80%) of the revenues are currently from the food processing business, but it is expected that the restaurant chain will provide up to 40% of General Stuff's revenues within three years. General Stuff's net profit margin last year was 5%, but the typical net profit margin for retail food businesses is 10%. General Stuff's return on assets last year was 25% and return on equity was 40%.
The beta (an indicator of an asset's systematic risk) assigned to General Stuff's common stock by a major financial analysis service was 1.2 prior to its acquisition of the restaurant chain. The beta was revised upward slightly to 1.3 following this acquisition.
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Other firms in the food processing industry have capital structures comprising 40% debt and 60% equity, though the use of debt ranges from a low of 15% to a high of 72%. Firms in the retail food industry have capital structures of 45% debt and 55% equity, ranging from 35% to 70% debt.
a. Compare General Stuff's capital structure with that of the industry.
b. Provide a recommendation for the amount of debt and equity
General Stuff should issue to support the expansion program.
List any assumptions you have made in your analysis. Briefly discuss additional information that would be useful in making a recommendation.