(Learning Objective 4: Analyzing alternative plans for raising money) First Federal Financial Services is considering two plans for raising €600,000 to expand operations. Plan A is to borrow at 5%, and plan B is to issue 100,000 shares of share capital at €6.00 per share.

Before any new fi nancing, First Federal Financial Services has a net income of €400,000 and 100,000 shares of share capital outstanding. Assume you own most of First Federal Financial Services’ existing shares. Its management believes the company can use the new funds to earn additional income of €550,000 before interest and taxes. First Federal Financial Services’

income tax rate is 40%.

❙ Requirements 1. Analyze First Federal Financial Services’ situation to determine which plan will result in the higher earnings per share.

2. Which plan results in the higher earnings per share? Which plan allows you to retain control of the company? Which plan creates more fi nancial risk for the company? Which plan do you prefer? Why? Present your conclusion in a memo to First Federal Financial Services’ board of directors.

Challenge Exercises