Bond and Stock Tourism Ltd is a mature company, currently financed 100% by shareholders' equity The company has 1 50 000 common stocks outstanding. trading at $3.00 per share on the stock market. Managers believe that the company will be able to earn a perpetual $90,000 net annual income before interest and tax (EBIT). Implying SO 42 camings per share. The company pursues a 100% payout dividend policy. Sharhiders d and a 12% annual return on their Investments The company s projected income statement and market data assuming zero growth are surm med t the follow ng table: Recently, managers of the company proposed a strategic expansion plan for sharcholders approval. The implementation of this expansion plan however, calls for a new capital investment of $250,000, which will be used to purchase new vehicles. Managers predict that annual EBIT will increase to $120,000 post new financing and expansion. An investment banker proposed to the company three alternative financing options for raising the $250,000 new capital: EBIT Interest expense Earming Before Tax Taxes (30%) Net Income Number of shares 90,000 90,000 27,000 63,000 150,000 Option A: Issue new stocks at the current market price of $3,00 each Option B: Issue a 10-year $1,000 face value ordinary bond money market environment. Option C: Issue a 10-year convertible bond carrying an 6% annual coupon with a conversion ratio of 250 (cach bond with a $1,000 face valuc can be converted to 250 shares). The convertible bond can be sold at its face value of $1,000, Th inEstment banker bclieesthe bond will be able to sllt ts face value in the current QUESTIONS 1. What are the benefits of convertible bond financing? In practice, which types of companies favor the use of coavertible bond financing? 2. What is a fair value of the company's stock, based on the managers' peediction of it future earnings? 3. What is the implied yield to maturity (YTM) of the ordinary bond in Option B 4 What is the conversion price of the convertible bond in Option C? What is the implied valuc of the conversion option for this bond? 5. The three financing options would affect the company's financial structure and financial performance differently. Estimate the post-expansion financial performance, total number of shares outstanding and EPS under each financing option. Include in your solutions the following table completed with your estimation results 6. Suppose you Post expansion Option A Option BOption C Option C. with zero with 100% EBIT $120,000 S120,000 S120,000 $120,000 Interest expense EBT Taxes (30%) Net income No. of shares outstanding Earnings per share EPS)
