Question

Financing alternatives The Howe Computer Company has growth rapidly during the past 5 years. Recently, its commercial bank urged the company to consider increasing its permanent financing. Its bank loan under a line of credit has risen to $170,000, carrying a 11% interest rate, and Howe has been 30 to 60 days late in paying trade creditors. Discussions with an investment banker have resulted in the decision to raise $220,000, at this time. Investment bankers have assured Howe that the following alternatives are feasible (flotation costs will be ignored): Alternative 1: Sell common stock at $10 per share. Alternative 2: Sell convertible bonds at a 11% coupon, convertible into 70 shares of common stock for each $1000 bond (i.e., the conversion price is $14.29 per share). Alternative 3: Sell debentures with a 11% coupon; each $1000 bond will have 70 warrants to buy 1 share of common stock at $14.29. Keith Howe, the president, owns 75% of Howe's common stock and wants to maintain control of the company; 45,000 shares are outstanding. The following are summaries of Howe's latest financial statements: Balance sheet Current liabilities $215,000 Common stock, $1 par 45,000 Retained earnings $25,000 Total assets $285,000 Total liabilities and equity $285,000 Income Statement Sales $520,000 All costs except Interest 462,800 EBIT $57,200 Interest $13,000 EBT $44,200 Taxes $17,680 Net income $26,520 Shares outstanding 45,000 Earnings per share $0.59 Price/earnings ratio 20 Market price of stock $11.79 Show the new balance sheet under each alternative. For alternative 2 and 3, show the balance sheet after conversion of the debentures or exercise of the warrants. Assume that $170,000, of the funds raised will be used to pay off the bank loan and the rest used to increase total assets. Round your answers to the nearest dollar. Total assets for Alternative 1 $ 334996 Total assets for Alternative 2 $ Total assets for Alternative 3 $ Show Keith Howe's control position under of each alternative, assuming that the does not purchase additional shares. Round your answers to the whole number. Original Plan 1 Plan 2 Plan 3 Percent ownership 75% % % % What is the affect on earnings per share of each alternative if it is assumed that earnings before interest and taxes will be 21% of total assets? Round your answers to the nearest cent. Original Plan 1 Plan 2 Plan 3 Earnings per share $0.59 $ $ $ What will be the debt ratio under each alternative? Round your answers to the whole number. Original Plan 1 Plan 2 Plan 3 Debt/assets ratio 75% % % % Which of the three alternatives would you recommend to Keith Howe? there is (are) maintenance of control for Keith Howe. are favorable alternatives, with being slightly more attractive, if Howe is willing to assume the risk of higher leverage. Why? The input in the box below will not be graded, but may be reviewed and considered by your instructor.

Answer 1

Balance sheet for alternative 1: as it is quite assumed one as it is difficult to find the data from above description:

Alternative 1

Total current liabilities $150,000

Long - term debt

common stock , par $1 162,500

paid-in-capital 437,500

Retained earnings 50,000

Total assets $800,000 total claims $800,000

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Alternative 2

Same as alternative 1

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Alternative 3

Total current liabilities $150,000

Long - term debt(8%) 500,000

common stock ,par $1 150,000

paid-in-capital 450,000

Retained earnings 50,000

Total assets $1,300,000 total claims $1,300,000

Ans B :

Original plan 1 plan 2 plan 3

Number of shares 80,000 80,000 80,000 80,000

Total shares 100,000 162,500 150,000 150,000

Percent ownership 80% 49% 53% 53%

Ans C :

Original plan 1 plan 2 plan 3

Total assets $550,000 $800,000 $800,000 $1,300,000

EBIT $110,000 $160,000 $160,000 $260,000      

Taxes(40%) 36000 64,000 64,000 88,000

Net income $54,000 $96,000 $96,000 $132,000

Earning per share $0.54 $0.59 $0.64 $0.88

Ans D :

  Original plan 1 plan 2 plan 3

Total debt $400,000 $150,000 $150,000 $650,000

Debt/assets ratio 73% 19% 19% 50%

so from above 4 parts of answer we can say that alternative 2 is better than alternative 1 and alternative 3 .