If the economy continues to be strong Carson Com- pany may need to increase i

If the economy continues to be strong Carson Com-
pany may need to increase its production capacity by
about 50 percent over the next few years to satisfy
demand. It would need financing to expand and
accommodate the increase in production. Recall that
the yield curve is currently upward sloping. Also recall
that Carson is concerned about a possible slowing of
the economy because of potential Fed actions to reduce
inflation. It needs funding to cover payments for sup-
plies. It is also considering issuing stock or bonds to
raise funds in the next year.
a. Assume that Carson has two choices to satisfy
the increased demand for its products. It could
increase production by 10 percent with its existing
facilities by obtaining short-term financing to cover
the extra production expense and then using a por-
tion of the revenue received to finance this level of
production in the future. Alternatively it could issue
bonds and use the proceeds to buy a larger facility
that would allow for 50 percent more capacity.
Which alternative should Carson select? b. Carson currently has a large amount of debt and its
assets have already been pledged to back up its existing
debt. It does not have additional collateral. At this time
the credit risk premium it would pay is similar in the
short-term and long-term debt markets. Does this imply
that the cost of financing is the same in both markets?
c. Should Carson consider using a call provision if it
issues bonds? Why? Why might Carson decide not to
include a call provision on the bonds?
d. If Carson issues bonds it would be a relatively small
bond offering. Should Carson consider a private
placement of bonds? What type of investor might be
interested in participating in a private placement? Do you
think Carson could offer the same yield on a private
placement as it could on a public placement? Explain.
e. Financial institutions such as insurance companies
and pension funds commonly purchase bonds. Explain
the flow of funds that runs through these financial
institutions and ultimately reaches corporations that
issue bonds such as Carson Company.