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 (i.e., 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 1share of common stock at $12.50.

Keith Howe, the president, owns 80% of Howe's common stock and wants 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 18

Market price of stock $8.64

Assume that $150,000 of the funds raised will be used to pay off the bank loan and the rest used to increase total assets.

1. What will be the debt ratio and earnings per share under each alternative after the conversion of the debentures or exercise of the warrants? Assume that earnings before interest and taxes will be 20% of total assets. (10 pts)
2. Which of the three alternatives would you recommend to Keith Howe? Why? (10 pts)