Topside Medical Goods is embarking on a massive expansion. Assume plans call for opening 20 new stores during the next two years. Each store is scheduled to be 30% larger than the company's existing locations, offering more items of inventory and with more elaborate displays. Management estimates that company operations will provide $1.0 million of the cash needed for expansion. Topside Medical must raise the remaining $7.5 million from outsiders.
The board of directors is considering obtaining the $7.5 million either by borrowing at 3% or by issuing an additional 500,000 shares of common stock. This year the company has earned $1 million before interest and taxes and has 500,000 shares of $1-par common stock outstanding. The market price of the company's stock is $15.00 per share. Assume that income before interest and taxes is expected to grow by 20% each year for the next two years. The company's marginal income tax rate is 40%. 1. Evaluate the effect the two financing alternatives will have on Topside's net income and earnings per share two years from now. 2. Complete the memo to Topside's management discussing the advantages and disadvantages of borrowing and of issuing common stock to raise the needed cash. Which method of raising the funds would you recommend? The advantages and disadvantages of borrowing to raise cash for expansion are as follows: (lf a box is not used in the table, leave the box empty; do not select a label.) Advantages Disadvantages Dilution of the ownership interests of existing stockholders. Increases the financial risk of the company. It avoids the creation of a liability and its related payments. It does not change the present ownership of the business. Results in a higher earnings per share of common stock. Results in a lower earnings per share of common stock. for expansion are as follows: (If a box is not used in the table, leave the box empty; do not select a label.) Disadvantages The method of raising funds that I would recommend depends upon the goal of the company in relation to this plan. The board of directors is considering obtaining the $7.5 million either by borrowing at 3% or by issuing an additional 500,000 shares of common stock. This year the company has earned $1 million before interest and taxes and has 500,000 shares of $1-par common stock outstanding. The market price of the company's stock is $15.00 per share. Assume that income before interest and taxes is expected to grow by 20% each year for the next two years. The company's marginal income tax rate is 40%. 1. Evaluate the effect the two financing alternatives will have on Topside's net income and earnings per share two years from now. 2. Complete the memo to Topside's management discussing the advantages and disadvantages of borrowing and of issuing common stock to raise the needed cash. Which method of raising the funds would you recommend? The advantages and disadvantages of borrowing to raise cash for expansion are as follows: (lf a box is not used in the table, leave the box empty; do not select a label.) Advantages Disadvantages Dilution of the ownership interests of existing stockholders. Increases the financial risk of the company. It avoids the creation of a liability and its related payments. It does not change the present ownership of the business. Results in a higher earnings per share of common stock. Results in a lower earnings per share of common stock. for expansion are as follows: (If a box is not used in the table, leave the box empty; do not select a label.) Disadvantages The method of raising funds that I would recommend depends upon the goal of the company in relation to this plan
