Reuth Corporation 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 owns 51.5% 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

Total Assets $2,600,00

Alternative 1: Common Stock $10

If new shares 200,000

Par value per share $.25

Alternative 2: Debentures

Exercise price per warrant $15

# bonds to raise new capital 2,000

# new shares 100,000

warrants per bond 50

New money raised 1,500,000

Addition to par 25,000

Additional Paid in-capital 1,475,000

Current Liabilities $900,000

Comon stock, par $0.25

Retained Earnings 700,000

Total Claims $2,600,000

Facts

Alt 1

Tax rate 20% #

New financing $2,000,000

Existing loan $600,000

Interest rate 10%

Interest amount-old $60,000

Interest rate- new $200,000

President owns 51.5%

Shares outstanding 4,000,000

a. Show the new balance sheet under both alternatives. For Alternatives 2, show the balance sheet after exercise 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. Calculate the debt ratio under both alternatives

e. Which alternative do you recommend and why?