Capital Generation Alternatives

Two capital generation alternatives for the Johnstown corporation were evaluated. The findings of this evaluation are presented in a separate section of this report. The market value of the firm was estimated through the application of alternative methodologies. The findings of these estimates also are presented in a separate section of this report. Recommendations with respect to both capital generation and the advisability of a decision to sell the firm are presented at the end of this report.

Evaluation of Capital Generation Alternatives

The Johnstown Corporation desires to generate $7.5 million in new capital. Two alternative approaches to the generation of this capital are being considered. These alternative approaches are (1) a common stock issue and (2) an issue of corporate bonds.

Common stock issue. A common stock issue would be an initial public offering. Since the Johnstown Corporation was formed through the acquisition of a mill from U.S. Steel Corporation, the equity of the firm has been closely held and the stock has not been publicly traded. Among steel making firms with similar product lines and production levels to those of Johnstown Corporation, the mean price/earnings (P/E) ratio for publicly traded equity shares in the relevant time period was 11.5:1. Thus, a prudent estimate for the P/E ratio for Johns

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six times cash flow, (3) 21 times 1987 earnings, and 18 times estimated 1988 earnings. Based on these methodologies, the estimated values of the firm are as follows: 1. 1.5 times book value: $5.4 million. 2. Six times cash flow: $16.2 million. 3. 21 times 1987 earnings: $37 million. 4. 18 times estimated 1988 earnings: $34.7 million. A mean of the four estimates would yield an estimated value of the firm of $23.3 million. The probability, however, is that the $16.2 cash flow-based estimate is the most accurate, as that value corresponds relatively well with the P/E-based value based on 1987 data. Recommendations The American steel industry is divided into two major groups·the integrated steelmakers and the general steelmakers. The integrated steelmakers use iron ore and coke in the production of carbon steel, while the general steelmakers use ferrous scrap in the production of carbon steel. In 1988, the integrated group accounted for two-thirds (66.7 percent) of American steel output with the remaining 33.3 percent being produced by the general steelmakers. Those percentages do not represent market shares for the two groups of producers, however, because foreign steelmakers held a 21 percent share of the American
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Approximate Word count = 1574
Approximate Pages = 6 (250 words per page)