Sub Contractor, Inc.

Sub Contractor, Inc. is a restaurant chain headquartered in Austin, Texas. In the past, capital investment decisions have been made, essentially, on an ad hoc basis. The company is in the process of implementing a rational approach to deciding upon which capital projects to implement.

In this case, the company has identified eight potential capital projects which would, if successfully implemented, be beneficial to the company. At this time, the company must decide, within the constraints of available capital and capital costs, which projects to implement.

An assumption was made that no project would be implemented, unless the internal rate of return for that project was higher than the company's marginal cost of capital. It was further assumed that, among those projects where the internal rate of return was higher than the marginal cost of capital, the projects with the highest internal rate of return will be given priority.

The company has three sources of investment capital: (1) debt, in the form of bonds, debentures, and convertible1 2 debentures; (2) preferred stock; and (3) common stock. The company's action alternatives involve the development of combinations of these sources to provide required investment capital, and within the framework of these combinations, the selection of projects for funding.

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hod is used in this case. Both requirements are imposedthe minimum project rate of return must exceed the company's marginal cost of capital, and projects with the highest returns are given preference. Within the context of these criteria, the analysis of the alternatives are as follows: 1. Fund all six projects$40.0 million; issue $33.9725 million in debt instruments, $4.0 million in preferred stock (yielding $3.84 million), and $2.5 million in common stock (yielding $2.1875 million). The marginal cost of capital for this alternative is 11.3 percent. Thus, projects "D," and "H" fall below the threshhold. Additionally, the issuance of 6 convertible debentures in a massive amount would be required, which would hold the potential of further diluting the equity of the common share holders. 2. Fund projects "A," "B," "E," and "F"$23 million; issue $16.9725 million in debt instruments, $4.0 million in preferred stock (yielding $3.84 million), and $2.5 million in common stock (yielding $2.1875 million). The marginal cost of capital for this alternative is 11.6 percent. Thus, all four projects are above the threshhold. Additionally, however, the issuance of converti
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Approximate Word count = 2788
Approximate Pages = 11 (250 words per page)