Question 2.(20 points) ReuthCorporation plans to raise $2 million to pay off its existing short-term bank loan of $600,000 and to increase total assets by $1,400,000.The bank loan bears an interest rate of 10 percent.The company's president owns51.5% percent of the 4,000,000 shares of common stock and wishes to maintain control of the company. The company's tax rate is 20 percent.Balance sheet information is shown below.

The company is considering two alternatives to raise the $2 million: (1) sell common stock at $10 per share, or (2) Sell bonds at a 10 percent coupon, each $1,000 bond carrying 50 warrants to buy common stock at $15 per share.

Current Balance Sheet

Current Liabilities $900,000

Common Stock, Par $0.25 1,000,000

Retained earnings 700,000

Total Assets $2,600,000 Total claims $2,600,000

Alternative 1: Common stock $10

FACTS

Alternative 1: Common stock

# new shares 200,000

Tax rate 20% # new shares

Par value per share $0.25

New financing $2,000,000 Par value per share

Existing Loan $600,000

Alternative 2: Debentures

Interest rate 10% Alternative 2: Debentures

Exercise price per warrant $15

Interest amount - old $60,000 Exercise price per warrant

# bonds to raise new capital 2,000

Interest amount - new $200,000 # bonds to raise 2M

# new shares 100,000

# new shares

warrants per bond 50

President owns 51.5% warrants per bond

New money raised 1,500,000

Shares outstanding 4,000,000 New money raised

Addition to par 25,000

Addition to par

Additional paid-in capital 1,475,000

Additional paid-in capital

a.Show the new balance sheet under both alternatives.For Alternatives 2, show the balance sheet afterexercise of the warrants.

b.Calculate the president's ownership position for both alternatives.He doesn't buy any of the additional shares.

c.Calculate earnings per share for both alternatives, assuming that EBIT is 11% of total assets

d.Calculatethe debt ratio under both alternatives

e.Which alternative do you recommend and why?