## Nokia India Battery Recall Logistics Case Solution

**Option 1-Debt financing**

Financing option is analyzed under the both optimistic and pessimistic approach. Debt financing is somewhat a risky finance option as the company not only has to pay the interest expense regularly on an annual basis but it also has to pay the principle amount without any default. However, the interest expense provides tax shield that increases the profit. Now considering the numerical analysis, it is shown that the cost of capital is higher in option 1 with 6.20% as compared to option 2, therefore employing the capital in investment is more expensive in option 1.

Moreover, in orderto further analyze the finance option, interest coverage ratio and FCF per interest ratio arecalculated. For this calculation, first of all, FCFF is calculated for Broadway under both approaches. Hence, byusing this FCFF under **Optimistic approach** the results are shown as:

Interest Coverage |
Â |
1.44 |
1.29 |
1.58 |
1.93 |
2.21 |
2.42 |
2.66 |
2.94 |
3.07 |
2.17 |

FCFF/Interest Ratio |
Â |
0.87 |
0.87 |
1.05 |
1.26 |
1.42 |
1.54 |
1.66 |
1.77 |
1.77 |
1.36 |

This can be seen that the average interest coverage ratio is 2.17 andthe FCFF/interest ratio is calculated to be 1.36. The interest coverage ratio indicates that the company is earning at a level that it can pay up to 2.17 times the current interest expense.The FCFF/interest ratio indicates that for every $1 obligation of interest payment, thecompany is earning $1.36 of FCFF.

Under the **Pessimistic Approach**, the results are shown as:

Interest Coverage |
Â |
1.27 |
1.08 |
1.22 |
1.49 |
1.68 |
1.83 |
1.99 |
2.18 |
2.25 |
1.67 |

FCF/Interest Ratio |
Â |
0.79 |
0.78 |
0.87 |
1.04 |
1.16 |
1.25 |
1.33 |
1.41 |
1.39 |
1.11 |

Over here,the average interest coverage ratio is 1.67 and FCF interest ratio is 1.11. Therefore,the results are lower than the optimistic approach.

**Option 2-Combination of Debt and equity Financing**

Under this option, a combination of debt and equity financing is being used, which is 50% debt and 50% equity, thus $60 million from debt and $60 million from financing. The cost of capital under this method is quite low as compared to option 1. The cost of capital is 4.27%, therefore in this option there is less cost of investment. On the other hand,using the **Optimistic approach,** the ratios are calculated as:

Interest Coverage |
Â |
3.16 |
2.84 |
3.34 |
3.90 |
4.25 |
4.44 |
3.65 |

FCF/Interest Ratio |
1.92 | 1.91 | 2.21 | 2.55 | 2.74 | 2.87 | 2.37 |

It can be seen that the average interest coverage ratio is 3.65 and theFCFF/interest ratio is calculated to be 2.37. The interest coverage ratio indicates that the company is earning at a level that it can pay up to 3.65 times the current interest expense. The FCFF/interest ratio indicates that for every $1 obligation of interest payment, thecompany is earning $2.37 of FCFF. As per the results, this option is more favorable than option 1.

Under the **Pessimistic Approach**, the results are shown as:

Interest Coverage |
Â |
2.80 |
2.38 |
2.57 |
3.00 |
3.24 |
3.36 |
2.89 |

FCF/Interest Ratio |
1.75 | 1.71 | 1.83 | 2.10 | 2.24 | 2.34 | 1.99 |

The ratios are lower in this option with Pessimistic approach, however they are favorable as compared to option 1.

Therefore, as far as ratios are analyzed, option 2 is the best mode of finance.

**Â ****Does Harris give up shareholder value by opting for the mix of debt and equity financing alternative? What is the relevant cost of equity dilution?**

**Shareholdersâ€™ value**

If Harris opts for option 2 financing, then he should use mix of financing option which will result in 50% debt and 50% equity issue. Therefore,in this scenario, the shareholdersâ€™ value will be reduced, asthe equity issue will increase the number of stockholders. Moreover, there will be dilution of control which would reducethe controlling ratio of each shareholder. In addition to this, theCost of Equity is calculated using the MM proposition II Formula, (Cost of equity, n.d). The cost of equity will be less as compared to option 1 financing as well by opting for this option. This can be shown as per the calculation, see excel. Therefore,it could be said that thereis some value that is given up by Harris.

**Cost of equity dilution**

The cost of equity dilution is shown below,

Current Cost of Equity- option 2 |
10.91% |

Cost of Equity (with mix of debt & equity financing) |
17.135303682036700% |

Relative cost of equity dilution |
6% |

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