Question

Early in the 2020, Baladna Co. prepared an expansion plan. The plan requires an increase in in both property, plant and equipment and inventory by $190,000,000 and $10,000,000 respectively. The following three alternative financing plans have been suggested by the firm’s investment bankers:

Plan I: issue preferred stock at par.

Plan II: issue common stock at $10 per share.

Plan III: issue a 16% long-term bonds, due in 20 years, at par ($1,000).

BALADNA CO.

Balance Sheet as of December 31, 2019 (in thousands)

Assets

Current assets:

Cash                                                                                                   $ 50,000

Accounts receivable                                                                             60,000

Inventory                                                                                             106,000

Total current assets                                                                           $216,000

Property, plant, and equipment                             $504,000

Less: Accumulated depreciation                             140,000                364,000

Patents and other intangible assets                                                       20,000

Total assets                                                                                        $600,000

Liabilities and Stockholders’ Equity

Current liabilities:

Accounts payable                                                     $ 46,000

Taxes payable                                                             15,000

Other current liabilities                                               32,000

Total current liabilities                                                                        $ 93,000

Long-term debt                                                                                     100,000

Stockholders’ equity:

Preferred stock ($100 par, 10% cumulative, 500,000 shares

authorized and issued)                                                                           50,000

Common stock ($1 par, 200,000,000 shares authorized,

100,000,000 issued)                                                                            100,000

Premium on common stock                                                                120,000

Retained earnings                                                                               137,000

Total liabilities and stockholders’ equity                                          $600,000

1. Which financing alternative costs Baladna Co. less: bonds payable or preferred stock? Why? (show computations).

Answer 1

Cost to the company from all the sources -

a. Preferred stock financing alternative costs Baladna Co. $20,000,000 and from Bonds payable it cost $32,000,000 even if the company charged tax on the income net income after tax $22,400,000 (Tax 30% - $9,600,000)