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).

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

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

Answer 1

Given data follows below:

Early in the 2020, Baladna Co. prepared an expansion plan Property, plant and equipment = $190,000,000

Early in the 2020, Baladna Co. prepared an expansion Inventory = $10,000,000

Plan I : Calculating issue preferred stock at par.

Property, plant and equipment + prepared an expansion Inventory.

=  $190,000,000 + $10,000,000

Total = $200,000,000

Given stock percentage = 10%

From the table cumulative = 500,000

Preferred stock = $200,000,000

Cost per year:

= Preferred stock x stock percentage

= $200,000,000 x 10%

=$20,000,000.

Plan II - Calculating common stock at $10 per share

Property, plant and equipment + prepared an expansion Inventory.

=  $190,000,000 + $10,000,000

Total = $200,000,000

Common stock ($1 per , 200,000,000 share ,1,000,000,000) = 200,000,000

Total = $1,800,000,000.

Plan III:

Property, plant and equipment + prepared an expansion Inventory.

=  $190,000,000 + $10,000,000

Total amount = $200,000,000

Calculating long term bond

Total amount / $1000

= $200,000,000 / $1000

=$ 200,000

Calculating interest cost

Total amount x issuse interest

$200,000,000 x 16%

=$32,000,000

Which financing alternative costs Baladna Co. less: bonds payable or preferred stock

Baladna Co. preferred cost : $20,000,000 , bond payment amount :$200,000,000 x 16% ; $32,000,000

Net income after tax

$32,000,000 - $9,600,000

= $22,400,000

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