QUESTION 4: FGE Company Limited is planning to raise new capital for expansion and is currently looking at the following alternatives: Option 1: Issue $2,000,000 Debentures, at par, at interest rate of 11% Option 2: Issue new common stocks at issue price of $5.00 per share The present total market capitalization of FGE is as follows: 1,000,000 $1.00 par value common stock, current market price of $5.00 per share 5,000 $5,000,000 $5,000,000 10% Debentures valued at par Current earnings before interest & taxes are $1,214,286 and the company is in the 30% tax bracket. Current P/E ratio is 10. With the expansion, FGE has developed the following EBIT estimates: Probability New EBIT $1,200,000 $1,600,000 $2,400,000 State of Economy Normal 60% 20% Weak 20% Strong Depending on the financing options chosen, the P/E ratio is expected to change as follows: Expected New P/E 8.5 x Option 1: Debt issue 11.0 x Option 2: Common stock issue Which financing option should be chosen? What is the basis of your decision? [Total: 15 marks]