Question 2: Capital Raising Alternatives50 Marks

Non-Stop Limited has grown rapidly during the past three years. The company is considering to

raise $50 million in order to finance the company's operations as well as to replace the

company's short-term debts. Currently, the company has 20 million of ordinary shares

outstanding. The company's tax rate is 28%. The following are extracts of the company's latest

financial statements:

Balance Sheet

Current liabilities$30,000,000

Ordinary shares, par $1$20,000,000

Retained earnings$10,000,000

Total assets$60,000,000Total claims$60,000,000

Income Statement

Earnings before interest and taxes$15,000,000

Interest$4,500,000

Earnings before taxes$10,500,000

Taxes (28%)$2,940,000

Net income$7,560,000

The company's investment banker has assured the company that the following alternatives are

feasible (flotation costs will be ignored):

Alternative 1:Sell ordinary shares at $4.

Alternative 2:Sell convertible bonds at an 8% coupon; immediately convertible into

200 ordinary shares for each $1,000-par-value bond

Alternative 3:Sell bonds at an 8% coupon, each $1,000-par-value bond carrying

200 warrants immediately exercisable into ordinary shares at $5 per

share

Based on the above information provided, you are required to answer the following questions:

a) Suppose the company will spend half of the funds raised to pay off the short-

term debts and the other half to increase total assets. Construct the new

balance sheet under each alternative. For Alternatives 2 and 3, show the

balance sheet after conversion of the bonds or exercise of the warrants.[18 marks]

b) Assess the effect of capital raising on earnings per share of the company

under each alternative. Assume that earnings before interest and taxes

(EBIT) will be 25% of total assets. [9 marks]

c)Assume that Mr. Bill Marks owned 65% of the company's ordinary shares.

Suppose he did not purchase the company's convertible bonds or bond with

warrants. Assess the effect of capital raising on his percentage ownership

under each alternative. Which alternative should he select? Support your

answer with calculations and discussion. [17 marks]

d) What will be the debt ratio (total liabilities / total assets) under each

alternative?