2-6 Two textile companies, Meyer Manufacturing and Haugen Mills, began operations with identical balance sheets. One year later, both required additional manufacturing capacity, which could be obtained by purchasing a new machine for $200,000. To raise the needed funds, Meyer issued a five-year, $200,000 bond with a coupon rate equal to 8 percent. Haugen, on the other hand, decided to sell common stock to raise the $200,000. The stock was sold for $50 per share, and the issue increased the number of outstanding, or existing, shares by 20 percent from the pre-issue level. All previous issues of stock were sold for $50 per share also. The balance sheet for each company, before the asset increases, is as follows: Total assets $400,000 Debt Equity Total liabilities and equity $200,000 200,000 $400,000 a. Show the balance sheet of each firm after the asset is purchased. b. How many shares of stock did Haugen have outstanding before the equity issue? How many are outstanding after the issue? C. With the additional manufacturing capacity provided by the machine, the oper- ating earnings (before taxes and interest payments) of each company will increase by $100,000. How much of this amount could be paid to the shareholders of each company? Assume that the tax rate for both companies is 40 percent. d. How much of the $100,000 operating earnings could be paid as dividends to each share of stock for each company (i.e., the additional earnings per share)? Assume that both companies had the same number of outstanding shares of stock prior to the purchase of the new machine. 2-7 The Cox Computer Company has grown rapidly during the past five years. Recently, its commercial bank urged the company to consider increasing its per- manent financing. Its bank loan has risen to $150,000 and carries a 10 percent interest rate, and Cox has been 30 to 60 days late in paying its suppliers. Discussions with an investment banker have resulted in the decision to raise $250,000 at this time. Investment bankers have assured Cox that the following alternatives are feasible (issuing costs will be ignored): " " Alternative 1-Sell common stock at $10 per share. Alternative 2-Sell convertible bonds with a 10 percent coupon, convertible into 80 shares of common stock for each $1,000 bond (i.e., the conversion price is $12.50 per share). Alternative 3-Sell debentures with a 12 percent coupon; each bond will sell at its face value of $1,000 and will have a maturity of 10 years. Charles Cox, the president, owns 80 percent of Cox's common stock and wishes to maintain control of the company; 50,000 shares are outstanding. The following are summaries of Cox's latest financial statements: Balance Sheet Income Statement Total assets $275,000 Sales $550,000 Short-term debt (bank 175,000 All costs except interest (495,000) loans, etc.) Bonds 25,000 Earnings before $ 55,000 Common stock, $1 par 50,000 interest and taxes Interest (15,000) Retained earnings 25,000 Earnings before taxes $ 40,000 Total liabilities and equity $275,000 Taxes at 40% (16,000) Net income $ 24,000 Shares outstanding 50,000 Earnings per share $ 0.48 $ 8.64 Market price of stock a. Show the new balance sheet under each alternative. For Alternative 2, show the balance sheet after conversion of the bond into stock. Assume that $150,000 of the funds raised will be used to pay off the bank loan and the rest will be used to increase total assets. b. Show Charles Cox's control position under each alternative, assuming that he does not purchase additional shares. C. What is the effect on earnings per share of each alternative if it is assumed that earnings before interest and taxes will be 20 percent of total assets? [Hint: Earnings per share (Net income//(Shares outstanding).] d. Which of the three alternatives would you recommend to Charles Cox, and why? 2-9 Fibertech Corporation just received an invoice from a Japanese manufacturer. The invoice states that Fibertech must pay the Japanese company 5,500,000 yen (the Japanese currency) in 90 days. If Fibertech pays the bill today, it needs $500,000 because each yen currently costs $0.09091 (i.e., $1 can purchase 11 yen). Fibertech is considering waiting to pay until the bill is due because to pay today it would have to borrow the needed funds at a very high interest rate. In 90 days, the firm expects to have collected funds from outstanding sales that will be more than sufficient to pay the Japanese manufacturer. a. Give some reasons Fibertech might want to pay the bill today rather than wait for 90 days. Give some reasons for not paying the bill until it is due. b. Suppose Fibertech can obtain a futures contract for delivery of 5,500,000 yen in 90 days, but it will cost $0.095 for each yen at delivery. In U.S. dollars, how much will Fibertech have to pay to settle its bill in 90 days with this contract? C. Assume that Fibertech chooses not to take the futures contract described in part (b). In U.S. dollars, how much will the company have to pay if the exchange rate in 90 days is $0.10 per yen? If it is $0.085 per yen? d. What primary benefit would Fibertech derive from entering into the futures contract?