Name : MARK PAULO D.

MENDOZA
Subject : MBA - FMAP
Date : March 12, 2021

INTEGRATIVE CASE 1: MERIT ENTERPRISE CORP.

1. INTRODUCTION

Sara Lehn, chief financial officer of Merit Enterprise Corp., was reviewing her
presentation one last time before her upcoming meeting with the board of directors. Merit’s
business had been brisk for the last two years, and the company’s CEO was pushing for a
dramatic expansion of Merit’s production capacity. Executing the CEO’s plans would require $4
billion in capital in addition to $2 billion in excess cash that the firm had built up. Sara’s
immediate task was to brief the board on options for raising the needed $4 billion.

Unlike most companies its size, Merit had maintained its status as a private company,
financing its growth by reinvesting profits and, when necessary, borrowing from banks. Whether
Merit could follow that same strategy to raise the $4 billion necessary to expand at the pace
envisioned by the firm’s CEO was uncertain, though it seemed unlikely to Sara. She had
identified two options for the board to consider:

Option 1: Merit could approach JP Morgan Chase, a bank that had served Merit well for
many years with seasonal credit lines as well as medium-term loans. Lehn believed that
JPMorgan was unlikely to make a $4 billion loan to Merit on its own, but it could probably
gather a group of banks together to make a loan of this magnitude. However, the banks would
undoubtedly demand that Merit limit further borrowing and provide JPMorgan with periodic
financial disclosure so that they could monitor Merit’s financial condition as it expanded its
operations.

Option 2: Merit could convert to public ownership public ownership, issuing stock to the
public in the primary market. With Merit’s excellent financial performance in recent years, Sara
thought that its stock could command a high price in the market and that many investors would
want to participate in any stock offering that Merit conducted. Becoming a public company
would also allow Merit, for the first time, to offer employees compensation in the form of stock
or stock option, thereby creating stronger incentives for employees to help the firm succeed. On
the other hand, Sara knew that public companies faced extensive disclosure requirements and
other regulations the Merit had never to confront as a private firm. Furthermore, with stock
trading in the secondary market, who knew what kind of individuals or institutions might wind
up holding a large chunk of Merit stock?

2. OBJECTIVE

Options to recommend Sara to consider in briefing the Board on how to raise a 4 billion
capital expansion capacity of the company

3. ALTERNATE COURSES OF ACTION

Option 2: Merit could convert to public ownership public ownership, issuing stock to the
public in the primary market. With Merit’s excellent financial performance in recent years, Sara
thought that its stock could command a high price in the market and that many investors would
want to participate in any stock offering that Merit conducted.

4. DISCUSSION

Option 1: Approaching JP Morgan Chase Bank and apply for a loan

Sara Lehn considers when asked to raise the $4 billion expansion capital to be borrowed
and apply as loan by the CEO from JP Morgan Chase bank which they have previously made
business with. The problem this time is that the amount they are going to borrow is much bigger
compared to the seasonal credit lines and medium term loans they made before. JP Morgan has
served with Merit for many years with seasonal credit lines as well as a medium-term loan.
Depending on how company goes they may need a long-term loan to be used as a capital. Since
they would consider having the loans from different banks if the business does not produce
enough profit and cash flow there would be a chance that Merit Enterprise reaches bankruptcy.
Comparing will have the advantage in their finances by demanding periodic financial disclosures
to monitor Merit’s financial conditions while their operation is increasing. The bank may lay
down certain restrictions that can affect future financing.

Covenants will also be imposed by the JP Morgan Chase to Merit Enterprise to when
they lent them money. Covenants in Banks are formal agreement placed on debts/loans that will
act as a bond to stabilize corporate relationships between the two individuals and reduce the
risk a bank is exposed when giving a large amount of money to a company. Merit Enterprise
when issued a covenant can’t apply and issue another loan until it is completely paid off and this
would effect on how they can raise capital on their expansion. JP Morgan also require a frequent
review of Merit’s financial statements during the expansion projects to determine its financial
condition. If everything will not go well as planned and succeed, the company will be the only
held liable and failure on paying back the loan can result in a lawsuit case, which can lead to a
bad image/reputation for the company and further bankruptcy as the worst possible outcome.

If JP Morgan Chase Bank continues to extend the season credit lines and medium terms
loans, then it would make Merit Enterprise as a private company and would have the right of
non-disclosure of its operation details. JP Morgan Chase has served Merit Enterprise Corp for
many years. The 4-billion-dollar loan can come quickly from comparing Morgan Chase by
gathering a group of banks together to make a loan of this magnitude. Being an Investment
bank, it can help Merit Enterprise Corp. look for and increase its capital and engage in the
trading and marking making activities. Merit Enterprise Corp. can discuss the terms with Morgan
Chase Bank to apply and have a low interest rate.
 Merit Enterprise Corp. can also have its loan debts work as tax shields. As we all know
interest paid on debts is a tax-deductible expense, so the company may save some money by
financing and paying with debts instead of going public. The higher the company investment,
the higher the interest is. Therefore, the deduction in taxes will be high, and will save the
company from paying so much amount. Another aspect is that the company will no longer have
to search for investors. The bank there will work to raise the money needed and give it to the
company. So, the company will not have to contact third parties that may even be risky and
jeopardize the plans of the firm.

Option 2: Converting/transforming Merit Enterprise into Public ownership

Sara’s second option is to transform the company in a public one. Merit Enterprise is
known to have excellent financial performance throughout the years. Many investors may be
willing to participate in stock offered by Merit which could command a high value in the market.
If many people are to invest to Merit Enterprise, the company can reach its goal to raise the of
$4 billion quickly. The more shares of stock the investors own; the more dividends will come
when the company makes a profit and this will give the company more equity. If your public
company performs well, the value its stock tends to increase. This is one of the foremost
reasons to Go Public, the future value of the company stock. But if the company doesn’t do so
well the risk and burden will be divided also into the Investors. Also, going public would allow
Merit Enterprise to offer stock and stock options to their employees which is an additional
incentive to contribute to the success of the company.

As Merit Enterprise becomes a public company, it will have them subject to extensive
disclosure requirements and other regulations. When issuing a stock, investors can purchase
shares, which will give them an equal portion of ownership in the company. Shareholders will
monitor the business operation. Going into public would leave Merit Enterprise vulnerable to
takeovers or other institutions holding a large portion or majority of the stock that may cause
them to lose control of their company.  Public companies also are faced with the added pressure
of the market which may cause them to focus more on short-term results rather than long-term
growth. The actions of the company's management also become increasingly scrutinized as
investors constantly look for rising profits. This may lead management to perform somewhat
questionable practices in order to boost earnings.

5. DECISION

I think Sara should recommend option 2 for consideration to the board; as the company
is on a growth trajectory there could be continuous demand for funds which cannot be met by
only retained earnings and debt alone, therefore keeping the future in perspective equity issue
will be a good decision. The final objective of any company is to improve performance, growth
and shareholder wealth which can be met by growing in size unless these objectives are
replaced by management control as a private company will have a growth limited by the funds
available for investment. Though cost of equity is high there are no fixed financial payments
linked to it like repayment of loans/debts. Even though Merit will require larger financial and
other disclosures, this will only bring in more transparency and better corporate governance in
the company. Though both equity and debt have their pros and cons, an equity issue also
increases the debt capacity of the firm as the firm can resort to higher debt in future.