Problem 20-9 Financing alternatives

The Howe Computer Company has grown 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 $150,000, carrying a 10% 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 $10 per share.
• Alternative 2: Sell convertible bonds at a 10% coupon, convertible into 80 shares of common stock for each $1,000 bond (that is, the conversion price is $12.50 per share).
• Alternative 3: Sell debentures with a 10% coupon; each $1,000 bond will have 80 warrants to buy 1 share of common stock at $12.50.

Keith Howe, the president, owns 80% of Howe's common stock and wishes to maintain control of the company; 50,000 shares are outstanding. The following are summaries of Howe's latest financial statements:

Balance Sheet
			Current liabilities	$200,000
			Common stock, $1 par	50,000
			Retained earnings	25,000
Total assets	$275,000		Total liabilities and equity	$275,000

Income Statement
	Sales	$550,000
	All costs except interest	495,000
	EBIT	$55,000
	Interest	15,000
	EBT	$40,000
	Taxes (40%)	16,000
	Net income	$24,000
	Shares outstanding	50,000
	Earnings per share	$0.48
	Price/earnings ratio	18x
	Market price of stock	$8.64

1. Show the new balance sheet under each alternative. For Alternatives 2 and 3, show the balance sheet after conversion of the debentures or exercise of the warrants. Assume that $150,000 of the funds raised will be used to pay off the bank loan and the rest to increase total assets. Round your answers to two decimal places.

   Alternative 1:
   		Total current liabilities	1. $
   		Long-term debt	-
   		Common stock, par $1	2. $
   		Paid-in capital	3. $
   		Retained earnings	4. $
   Total assets	5. $	Total liabilities and equity	6. $

   Alternative 2:
   		Total current liabilities	7. $
   		Long-term debt	-
   		Common stock, par $1	8. $
   		Paid-in capital	9. $
   		Retained earnings	10. $
   Total assets	11. $	Total liabilities and equity	12. $

   Alternative 3:
   		Total current liabilities	13. $
   		Long-term debt (10%)	14. $
   		Common stock, par $1	15. $
   		Paid-in capital	16. $
   		Retained earnings	17. $
   Total assets	18. $	Total liabilities and equity	19. $

2. Show Keith Howe's control position under each alternative, assuming that he does not purchase additional shares. Round your answers to two decimal places.

   	Plan 1	Plan 2	Plan 3
   Percent ownership	20. %	21. %	22. %

3. What is the effect on earnings per share of each alternative if it is assumed that earnings before interest and taxes will be 20% of total assets? Round your answers to two decimal places.

   	Original	Plan 1	Plan 2	Plan 3
   Earnings per share	23. $	24. $	25. $	26. $

4. What will be the debt ratio under each alternative? Round your answers to two decimal places.

   	Plan 1	Plan 2	Plan 3
   Debt/assets ratio	27. %	28. %	29. %