Sullivan Medical Goods is embarking on a massive expansion. Assume plans call for opening 20 new stores

Question:

Sullivan Medical Goods is embarking on a massive expansion. Assume plans call for opening 20 new stores during the next two years. Each store is scheduled to be 30% larger than the company’s existing locations, offering more items of inventory and with more elaborate displays. Management estimates that company operations will provide $1.0 million of the cash needed for expansion. Sullivan Medical must raise the remaining $5.5 million from outsiders.

The board of directors is considering obtaining the $5.5 million either by borrowing at 6% or by issuing an additional 250,000 shares of common stock. This year the company has earned $4 million before interest and taxes and has 250,000 shares of $1-par common stock outstanding. The market price of the company’s stock is $22.00 per share. Assume that income before interest and taxes is expected to grow by 10% each year for the next two years. The company’s marginal income tax rate is 35%.


Requirements

1. Use Excel to evaluate the effect the two financing alternatives will have on Sullivan’s net income and earnings per share two years from now.

2. Write a memo to Sullivan’s management discussing the advantages and disadvantages of borrowing and of issuing common stock to raise the needed cash. Which method of raising the funds would you recommend?

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on...
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Financial Accounting

ISBN: 978-0134725987

12th edition

Authors: C. William Thomas, Wendy M. Tietz, Walter T. Harrison Jr.

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