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.
Meritâs business had been brisk for the last 2 years, and the companyâs CEO
was pushing for a dramatic expansion of Meritâs production capacity. Executing the
CEOâs plans would require $4 billion in capital in addition to $2 billion in excess
cash that the firm had built up. Saraâs 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 firmâs CEO was uncertain,
although it seemed unlikely to Sara. She had identified the following two options for
the board to consider.
Option 1: Merit could approach JPMorgan 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 disclosures so that it could
monitor Meritâs financial condition as Merit expanded its operations.
Option 2: Merit could convert to public ownership, issuing stock to the public
in the primary market. With Meritâs 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 options, 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
that Merit had never had 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?
TO DO
a. Discuss the pros and cons of option 1, and prioritize your thoughts. What are the
most positive aspects of this option, and what are the biggest drawbacks?
b. Do the same for option 2.
c. Which option do you think that Sara should recommend to the board, and why?
