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BACKGROUND

Delicious, Inc. founded by Harold Steinberg in 1922


-sound marketing and financial policies --> no debt and slow sales growth
-keeping the company private in order to maintain flexibility in setting policy and
In 1978, 892,000 common shares were outstanding
-60% ownded by Steinberg family
-remainder owned by former and current employees
If a shareholder wished to sell shares,

-he or she would have to sell them back to the firm at book value.
If the firm don't have the funds, the person would have to wait for ONE YEAR to receive the
EXCEPTION: If the shares were being sold for estate tax purposes (Mr. Steinberg would see

With this policy:


1. Although
Employees
who
tookwas
advantage
of the
firms
stock
plan
could
have
selh
2.
the
policy
that a seller
might
have
to option
wait one
year,
this
never
firm maintained a high level of liquidity.
3. The firm paid healthy dividends.
In late 1968, founder died - son Richard Steinberg assume presidency
- convince the board of directors to accept a goal of going public and to change

He proposed a three-phase plan:


1. The
First second
new product
rock candy)
would
require $5which
million.
It larger
would tha
tak
2.
phaseline
was(hard
a different
product
line (licorice),
was
product line of phase 1.
This
phase
begin
1976have
(aftertothe
of phase
1 could be(phase
evaluated
phase
2 thewould
product
lineinwould
be success
expanded.
This expansion
3) w
require about $2 million.

The board voted to accept phase 1 and finance it with a debt.


$5M, five year term loan, interest paid semi-annually starting 6 mos after the loa
In early 1976, the board decided to proceed with phase 2 and 3
Phase 2 would require $7M
Phase 3 would require $3M

Phase 2: finance $5M with debt and $2M with preferred stock
interest rate: 11% with annual principal payment of $1M starting December 31,
$2M, 12% preferred stock issue was privately placed with a pension fund. The fi

In mid-1977, however, it became apparent that the firm could not compete effectively with
the firm purchased $3 million worth of capital equipment and obtained a short-t

Loan officer offer:


3-year loan at 10.5%, principal payment required at the end of each of the three

Three offers from investment bankers and financial institutions

insurance company, which was willing to lend $3 million but wanted warrants to
purchase common stock.
The treasure thought that the number of new shares they wanted the right to pu

2) The second offer was from the pension fund that owned the $2 million of pref

This financial institution was willing to purchase an additional $3 million of 12-pe


commencing one year after the existing preferred stock was retired. The option

3) The third offer was from an investment company that had many wealthy clien
It was willing to underwrite class B shares in 10,000 share lots. Each of the 30 lo
through December 31, 1979. On January 1, 1980, each class B share would be c

slow sales growth


bility in setting policy and maintain control

ook value.
ONE YEAR to receive the funds
Mr. Steinberg would see to it that the shares were repurchase immediately

ption
plan
could
have
selected
an alternative
ait one
year,
this
never
happened
since the profit-sharing scheme.

ng public and to change its policy on the use of debt

ee),
$5which
million.
It larger
would than
take about
five years, until 1975
was
the

aseexpansion
1 could be(phase
evaluated)
and require about $6 million
his
3) would

arting 6 mos after the loan agreement was signed

M starting December 31, 1977


ith a pension fund. The firm had the option of calling $500,000 on the issue each year at par, commencing Dece

compete effectively with a partial product line; thus phase 3 had to begin as soon as possible.
nt and obtained a short-term loan from its commercial bank

end of each of the three years

n but wanted warrants to

ey wanted the right to purchase was too high, and that the proposed exercise price was too low.

ned the $2 million of preferred stocks.

tional $3 million of 12-percent preferred stock. Each year, $500,000 of the new preferred stock could be called
was retired. The option to convert to a five-year term loan commencing on January 1, 1987, would also apply to

t had many wealthy clients.


re lots. Each of the 30 lots would be sold for $100,000. The class B shares would have no voting rights or divide
class B share would be converted into a regular share, and hence at that time there would be only one class of c

Phase 2: $5,000,000 loan


Early 197
Principal D 5,000,000
Interest
Payment
Balance
5,000,000

at par, commencing December 31, 1979

$2M, 12% preferred stock issue was privat

Preferred stock
12% (Payment)

ed stock could be called at par,


1987, would also apply to these shares

no voting rights or dividend rights


uld be only one class of common stock

Balance
$3M, for purchase of capital equipment
Option 1: Loan from Commercial Bank
Principal Debt
Interest
Payment
Balance
Option 2: $3M preferred stocks at 12%
Preferred stock
12% (Payment)
Option 3: Underwrite Class B shares
Dividend Payments

12/31/1976 12/31/1977
1978
1979
1980
1981
5,000,000
5,000,000
4,000,000
3,000,000
2,000,000
1,000,000
550,000
550,000
440,000
330,000
220,000
110,000
(550,000) (1,550,000) (1,440,000) (1,330,000) (1,220,000) (1,110,000)
5,000,000
4,000,000
3,000,000
2,000,000
1,000,000
0

stock issue was privately placed with a pension fund. The firm had the option of calling $500,000 o
12/31/1977
2,000,000
240,000

1978
2,000,000
240,000
0

1979
2,000,000
240,000
(500,000)

1980
1,500,000
180,000
(500,000)

1981
1982
1,000,000 500,000
120,000
60,000
(500,000) (500,000)

f capital equipment
mmercial Bank

2,000,000

12/31/1977

1,500,000

1,000,000

500,000

1978
1979
1980
3,000,000
2,000,000
1,000,000
315,000
210,000
105,000
(1,315,000) (1,210,000) (1,105,000)
2,000,000
1,000,000
0

d stocks at 12%
12/31/1977
3,000,000
360,000

1978
3,000,000
360,000

1979
3,000,000
360,000

1980
3,000,000
360,000

1981
1982
3,000,000 3,000,000
360,000 360,000

1978
1,784,000

1979
1,784,000

1980
2,384,000

1981
1982
2,384,000 2,384,000

lass B shares

calling $500,000 on the issue each year at par, commencing December 31, 1979

EXHIBIT 1
Delicious, Inc.
Income Statements*
Years Ended 12/31
(000 omitted)

Net Sales
Cost of goods sold
Gross profit
Selling, general and administrative expenses
Operating income
Interest on term debt
Profit before taxes
Taxes @ 48%
Net Income
Preferred dividends
Earnings for common
No. of common shares outstanding
Earnings per share
Dividends per share

$
$
$
$
$
$

1977
79,388
51,476
27,912
20,897
7,015
550
6,465
3,103
3,362
240
3,122
892
3.50
2.00

* These statements have been restated to simplify the analysis. Interest expense on short-term debt i
included in selling, general and administrative expenses. Interest income on marketable securities is t
as a deduction form selling, general and administrative expense.

$
$
$
$
$
$

1976
77,115
50,986
26,129
20,049
6,080
140
5,940
2,851
3,089
64
3,025
892
3.39
2.00

se on short-term debt is
arketable securities is treated

EXHIBIT 2
Delicious, Inc.
Balance Sheets At 12/31
(000 omitted)

Cash and marketable securities


Accounts receivable, net
Inventories
Other current
Total current
Property, plant, and equipment, net
Other assets
Total
Notes payable
Accounts payable and accruals
Current portion of term debt
Other current
Total current
Term debt
Preferred stock
Common stock and surplus
Retained earnings
Total

1977
$
743
5,640
7,477
296
$
14,156
18,444
371
$
32,971
$

3,000.00
7,853
1,000
91
11,944
3,000
2,000
7,655
8,372
32,971

1976
$
566
5,542
$
7,322
361
$
13,791
15,219
462
$
29,472
7,599
1,000
87
8,686
4,000
2,000
7,655
7,131
29,472

EXHIBIT 3
Delicious, Inc.
Projected Sources and Uses of Funds
Years Ended 12/31
(000 omitted)
1978
Sources
Net income after taxes
Depreciation
Funds flow
Accounts payable and accruals
Total Sources
Uses
Working Capital
Fixed asset expenditures
Debt payments
Preferred sinking fund
Preferred dividends
Common dividends
Total Uses
Sources less Uses
Cumulative

$
$

$
$

4,019
300
4,319
150
4,469
600.00
150
1,000
240
1,784
3,774
695
695

* Flow-of-funds estimates include the increase in funds because of the $3 million capital expenditures
program but not the financial burden created by the new financing. In other words, new interest charg
new dividend requirements, or new sinking fund payments that will be required are not included. Also
estimates assume no increases in common dividend rate.

EXHIBIT 3
elicious, Inc.
urces and Uses of Funds*
rs Ended 12/31
000 omitted)
1979
$

$
$

$
$

1980

4,316
300
4,616
140
4,756

600.00
150
1,000
500
240
1,784
4,274
482
1,177

million capital expenditures


r words, new interest charges,
uired are not included. Also, the

$
$

1981

4,414
325
4,739
140
4,879

480.00
200
1,000
500
180
1,784
4,144
735
1,912

$
$

1982

4,622
325
4,947
135
5,082

470.00
200
1,000
500
120
1,784
4,074
1,008
2,920

4,842
325
5,167
130
5,297
460.00
200

$
$

500
60
1,784
3,004
2,293
5,213

EXHIBIT 4-A
A Company
Income Statements
Years Ended 19x
(000 omitted)

Net Sales
Cost of goods sold
Gross profit
Operating expenses
Earnings before interest and taxes
Interest expense
Earnings before taxes
Taxes @ 50%
Earnings after taxes
Less preferred dividends
Earnings available to common stock
No. of common shares outstanding
Earnings per share

EXHIBIT 4-B
A Company
EBIT-EPS Analysis
Years Ended 19x
(000 omitted)

EBIT
Existing interest
New Interest
Earnings before taxes
Income taxes @ 50%
Earnings after taxes
Existing preferred dividends
New preferred dividends
Earnings available to common stock
No. of common shares outstanding
Earnings per share

Debt
$ 1,200
100
50
$ 1,050
525
525
200
$
325
250
$
1.30

Preferred
$ 1,200
100
$ 1,100
550
550
200
45
$
305
250
$
1.22

$
$
$
$
$
$

10,000
7,000
3,000
2,000
1,000
100
900
450
450
200
250
250
1.00

Common
$
1,200
100
$
1,100
550
550
200
$
350
300
$
1.17

Delicious, Inc.
1. Evaluate the return and risk implications of the alternative financing plans.

2. If you were to negotiate the proposed loan terms with the bank, what would be the key e
of your counterproposal and how would you argue your case with the bank?

3. Comment on Mr. Steinberg's statement that shareholders should be happy with the divid
they were getting since, "Many people purchased their shares for $1 per share. On these sh
they will now earn a return of 165 percent!"
Yes, the shareholders should be happy with a return of 165 percent. Ev
there was a small increase in the dividend rate, the company have cons
declared dividends since 1940. Hence, they receive their fair share in t
profits annually.

4. Suppose the firm does not go public and does not increase its dividend above $2 per sha
What rate of return can the purchasers of Class B stock expect?
1 Lot = 10,000 share
30 Lots = 300,000 shares
Price per lot = $ 100,000
Price per share = $ 2.00
Dividend per share = $ 2.00
Expected dividend per lot = $ 20,000
5. Which alternative would you recommend?

Option 2 should be recommended as the best alternative. It has the 2n


and positive cumulative cash flow for the five year period.

cing plans.

what would be the key elements


he bank?

d be happy with the dividends


$1 per share. On these shares

urn of 165 percent. Even though


he company have consistently
ve their fair share in the company's

vidend above $2 per share.

ernative. It has the 2nd highest EPS


ar period.

(Status Quo)
Delicious, Inc.
EBIT-EPS Analysis
Years Ended 12/31
(000 omitted)
1978
Net income after taxes
Add back: Tax (48%)
Earnings before taxes (EBT)
Add back: Interest (11%)
EBIT
Existing interest
New Interest
Earnings before taxes
Income taxes @ 48%
Earnings after taxes
Existing preferred dividends
New preferred dividends
Earnings available to common stock
No. of common shares outstanding
Earnings per share

4,019
3,710
7,729
440
8,169
440
7,729
3,710
4,019
240
3,779
892
4.24

1979
$

4,316
3,984
8,300
330
8,630
330
8,300
3,984
4,316
240
4,076
892
4.57

o)

nc.
lysis
12/31
ed)
1980
$

4,414
4,074
8,488
220
8,708
220
8,488
4,074
4,414
180
4,234
892
4.75

1981
$

4,622
4,266
8,888
110
8,998
110
8,888
4,266
4,622
120
4,502
892
5.05

1982
$

4,842
4,470
9,312
9,312
9,312
4,470
4,842
60
4,782
892 Average
5.36
4.79

(Option 1: 3-year loan at 10.5%, principal payment $1M required at the end of each of the th
Delicious, Inc.
EBIT-EPS Analysis
Years Ended 12/31
(000 omitted)
1978

EBIT
Existing interest
New Interest
Earnings before taxes
Income taxes @ 48%
Earnings after taxes
Existing preferred dividends
New preferred dividends
Earnings available to common stock
No. of common shares outstanding
Earnings per share

After-tax dollar cost of debt

8,169
440
315
7,414
3,559
3,855
240
3,615
892
4.05

163.80

1979

8,630
330
210
$ 8,090
3,883
4,207
240
###
3,967
###
$
4.45

109.20

1980

8,708
220
105
$ 8,383
4,024
4,359
180
4,179
892
$
4.69

54.60

The fixed after-tax dollar cost of debt is less than tha

he end of each of the three years)

(Option 2: 12-p

Del
EBITYears
(00
1981

1982

8,998
110
$ 8,888
4,266
4,622
120
4,502
892
$
5.05

9,312
$ 9,312
4,470
4,842
60
4,782
892 Average
$
5.36
4.72

EBIT
Existing interest
New Interest
Earnings before taxes
Income taxes @ 48%
Earnings after taxes
Existing preferred dividends
New preferred dividends
Earnings available to common stock
No. of common shares outstanding
Earnings per share

Fixed dollar cost of preferred stock

debt is less than that for preferred stock, the debt option will produce a higher level of EPS than p

(Option 2: 12-percent preferred stock)


Delicious, Inc.
EBIT-EPS Analysis
Years Ended 12/31
(000 omitted)
1978

8,169
440
7,729
3,710
4,019
240
360
3,419
892
3.83

360

1979

8,630
330
###
$ 8,300
3,984
4,316
240
360
3,716
###
$
4.17

360

1980

8,708
220
$ 8,488
4,074
4,414
180
360
3,874
892
$
4.34

1981

8,998
110
$ 8,888
4,266
4,622
120
360
4,142
892
$
4.64

360

er level of EPS than preferred stock at any level of debt.

360

1982

9,312
$ 9,312
4,470
4,842
60
360
4,422
892 Average
$
4.96
4.39

360

(Option 3: Convertible Class B shares)


Delicious, Inc.
EBIT-EPS Analysis
Years Ended 12/31
(000 omitted)
1978

EBIT
Existing interest
New Interest
Earnings before taxes
Income taxes @ 48%
Earnings after taxes
Existing preferred dividends
New preferred dividends
Earnings available to common stock
No. of common shares outstanding
Earnings per share

8,169
440
$ 7,729
3,710
4,019
240
3,779
892
$
4.24

Existing No. of common shares outstanding


Additional shares
Total common shares outstanding
Fixed-percentage dilution

1979

8,630
330
8,300
3,984
4,316
240
4,076
892
4.57

892,000
300,000
1,192,000
25%

1980

8,708
220
###
$ 8,488
4,074
4,414
180
###
4,234
1,192
$
3.55

1981

8,998
110
$ 8,888
4,266
4,622
120
4,502
1,192
$
3.78

1982

9,312
$ 9,312
4,470
4,842
60
4,782
1,192 Average
$
4.01
4.03

(Status Quo)
Delicious, Inc.
Projected Sources and Uses of Funds*
Years Ended 12/31
(000 omitted)
1978
1979
Sources
Net income after taxes
Depreciation
Funds flow
Accounts payable and accruals
Total Sources
Uses
Working Capital
Fixed asset expenditures
Debt payments
Preferred sinking fund
Preferred dividends
Common dividends, $2
Total Uses
Sources less Uses
Cumulative

$
$

$
$

4,019
300
4,319
150
4,469

600.00
150
1,000
240
1,784
3,774
695
695

$
$

4,316
300
4,616
140
4,756
600.00
150
1,000
500
240
1,784
4,274
482
1,177

* Flow-of-funds estimates include the increase in funds because of the $3 million capital expenditures
program but not the financial burden created by the new financing. In other words, new interest charg
new dividend requirements, or new sinking fund payments that will be required are not included. Also
estimates assume no increases in common dividend rate.

DECISION: Therefore, Option 3 should be recommended as the best alternative since it pro

of Funds*

1
1980
$

$
$

$
$

1981

4,414
325
4,739
140
4,879

480.00
200
1,000
500
180
1,784
4,144
735
1,912

$
$

1982

4,622
325
4,947
135
5,082

470.00
200
1,000
500
120
1,784
4,074
1,008
2,920

4,842
325
5,167
130
5,297
460.00
200

$
$

500
60
1,784
3,004
2,293
5,213

apital expenditures
, new interest charges,
e not included. Also, the

native since it provide the highest EPS and cumulative cash flow for the five year period.

(Option 1: 3-year loan at 10.5%, principal payment $1M required at the end of each of th
Delicious, Inc.
Projected Sources and Uses of Funds*
Years Ended 12/31
(000 omitted)
1978
1979
1980
Sources
Net income after taxes
Depreciation
Funds flow
Accounts payable and accruals
Total Sources
Uses
Working Capital
Fixed asset expenditures
Debt payments
Preferred sinking fund
Preferred dividends
Common dividends, $2
Total Uses
Sources less Uses
Cumulative

sh flow for the five year period.

$
$

$
$

3,855
300
4,155
150
4,305

600.00
150
2,000
240
1,784
4,774
(469)
(469)

$
$

4,207
300
4,507
140
4,647

600.00
150
2,000
500
240
1,784
5,274
(627)
(1,096)

$
$

4,359
325
4,684
140
4,824
480.00
200
2,000
500
180
1,784
5,144
(320)
(1,416)

the end of each of the three years)

(Option

nds*

Projecte

1981
$

$
$

$
$

1982

4,622
325
4,947
135
5,082

470.00
200
1,000
500
120
1,784
4,074
1,008
(408)

4,842
325
5,167
130
5,297
460.00
200

$
$

500
60
1,784
3,004
2,293
1,885

Sources
Net income after taxes
Depreciation
Funds flow
Accounts payable and accruals
Total Sources
Uses
Working Capital
Fixed asset expenditures
Debt payments
Preferred sinking fund
Preferred dividends
Common dividends, $2
Total Uses
Sources less Uses
Cumulative

(Option 2: 12-percent preferred stock)


Delicious, Inc.
Projected Sources and Uses of Funds*
Years Ended 12/31
(000 omitted)
1978
1979
1980
$

$
$

$
$

4,019
300
4,319
150
4,469

600.00
150
1,000
600
1,784
4,134
335
335

$
$

4,316
300
4,616
140
4,756

600.00
150
1,000
500
600
1,784
4,634
122
457

$
$

1981

4,414
325
4,739
140
4,879

480.00
200
1,000
500
540
1,784
4,504
375
832

$
$

1982

4,622
325
4,947
135
5,082

470.00
200
1,000
500
480
1,784
4,434
648
1,480

4,842
325
5,167
130
5,297
460.00
200

$
$

500
420
1,784
3,364
1,933
3,413

(Option 3: Convertible Class B shares)


Delicious, Inc.
Projected Sources and Uses of Funds*
Years Ended 12/31
(000 omitted)
1978
1979
Sources
Net income after taxes
Depreciation
Funds flow
Accounts payable and accruals
Total Sources
Uses
Working Capital
Fixed asset expenditures
Debt payments
Preferred sinking fund
Preferred dividends
Common dividends, $2
Total Uses
Sources less Uses
Cumulative

$
$

$
$

4,019
300
4,319
150
4,469

600.00
150
1,000
240
1,784
3,774
695
695

$
$

4,316
300
4,616
140
4,756
600.00
150
1,000
500
240
1,784
4,274
482
1,177

e Class B shares)

s, Inc.
nd Uses of Funds*
d 12/31
itted)
1980
$

$
$

$
$

1981

4,414
325
4,739
140
4,879

480.00
200
1,000
500
180
2,384
4,744
135
1,312

$
$

1982

4,622
325
4,947
135
5,082

470.00
200
1,000
500
120
2,384
4,674
408
1,720

4,842
325
5,167
130
5,297
460.00
200

$
$

500
60
2,384
3,604
1,693
3,413

Earnings Coverage

=
i+

EBIT
SF
1-T

(Option 1: 3-year loan at 10.5%, principal payment $1M required at the en


1978
EBIT
Existing interest
New Interest
Total Interest
Preferred sinking fund
Earnings Coverage

8,169

440
210
650
12.58

1979
$

8,630

330
105
435
500
9.23

M required at the end of each of the three years)


1980
$

8,708

220
220

1981
$

8,998

110
110

(Option 2: 12-

1982
$

9,312
-

500

500

500

12.10

14.76

18.64

EBIT
Existing interest
New Interest
Total Interest
Preferred sinking fund
13.46 Earnings Coverage

(Option 2: 12-percent preferred stock)


1978
$

8,169

440
440
18.59

1979
$

8,630

330
330

1980
$

8,708

220
220

1981
$

8,998

110
110

1982
$

9,312
-

500

500

500

500

10.40

12.10

14.76

18.64

14.90

(Option 3: Convertible Class B shares)


1978
EBIT
Existing interest
New Interest
Total Interest
Preferred sinking fund
Earnings Coverage

8,169

440
440
18.59

1979
$

8,630

330
330

1980
$

8,708

220
220

1981
$

8,998

110
110

500

500

500

10.40

12.10

14.76

1982
$

9,312
500
18.64

14.90