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
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 8% 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 $250,000, 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 $9 per share.
- Alternative 2: Sell convertible bonds at a 8% coupon, convertible into 90 shares of common stock for each $1000 bond (i.e., the conversion price is $11.11 per share).
- Alternative 3: Sell debentures with a 8% coupon; each $1000 bond will have 90 warrants to buy 1 share of common stock at $11.11.
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 | $20,000 | ||
Total assets | $280,000 | Total liabilities and equity | $280,000 |
Income Statement | |||
Sales | $560,000 | ||
All costs except Interest | 515,200 | ||
EBIT | $44,800 | ||
Interest | $16,000 | ||
EBT | $28,800 | ||
Taxes | $11,520 | ||
Net income | $17,280 | ||
Shares outstanding | 45,000 | ||
Earnings per share | $0.38 | ||
Price/earnings ratio | 17 | ||
Market price of stock | $6.53 |
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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 $ 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 23% of total assets? Round your answers to the nearest cent.
Original Plan 1 Plan 2 Plan 3 Earnings per share $0.38 $ $ $ -
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 77% % % % -
Which of the three alternatives would you recommend to Keith Howe?
-Select-Alternative 1Alternative 2Alternative 3Each alternativeBoth Alternative 1 and Alternative 2Both Alternative 1 and Alternative 3Item 13 there is (are) maintenance of control for Keith Howe. -Select-Both Alternative 2 and Alternative 3Both Alternative 1 and Alternative 2Both Alternative 1 and Alternative 3Item 14 are favorable alternatives, with -Select-123Item 15 being slightly more attractive, if Howe is willing to assume the risk of higher leverage.
Why?
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