Greenway Television (Greenway) was recently granted the licenses by the CRTC to operate eight new digital specialty television channels.

Greenway plans to begin broadcasting within six to eight months. It already has agreements in principle with cable and satellite operators to include Greenway’s channels on their systems (although these agreements aren’t binding).

When Greenway was organized two years ago with the purpose of developing specialty channels, the company raised \($5,000,000\) by selling 2,000,000 common shares to investors. Now that Greenway has received its licenses from the CRTC, it’s in need of an additional \($5,000,000\) to go on air. Greenway’s CEO is considering two options:

sell additional shares in the company or borrow the required funds. If the company borrows, it will have to pay 10 percent interest per year. If it uses equity, it will have to sell 1,000,000 shares to raise the money.

The success of Greenway has two main elements—subscribers and advertising revenues.

The more subscribers it has and the more money advertisers are prepared to spend buying advertising time, the more successful Greenway will be. Once the channels are operating, Greenway will receive a fixed fee for each person who subscribes to a channel. Cable and satellite operators sometimes bundle channels, so if a channel is bundled with other channels that are attractive to viewers, the channel in question will generate revenues regardless of how many people watch it.

Greenway’s CEO has projected two possible outcomes: a good outcome and a poor outcome. Under the good outcome, the CEO estimates that income from operations

(income before considering financing costs) will be \($1,500,000\) in the first year. Under the poor outcome, the CEO estimates that income from operations will be \($300,000\) in the first year.

Assume that Greenway has a tax rate of 28 percent, and all tax effects are reflected in operating income except for the tax effect of the additional debt or equity.

Required:

a. Prepare partial income statements for Greenway assuming:

i. Equity financing of the additional \($5,000,000\) and the good outcome.

ii. Equity financing of the additional \($5,000,000\) and the poor outcome.

iii. Debt financing of the additional \($5,000,000\) and the good outcome.

iv. Debt financing of the additional \($5,000,000\) and the poor outcome.

b. Calculate basic earnings per share and return on shareholders’ equity for the four scenarios described in (a).

c. Explain the advantages and disadvantages of Greenway using debt and the advantages and disadvantages of it using equity.

d. If you were a prospective lender, would you lend \($5,000,000\) to Greenway? Explain.

e. Would you advise Greenway to use debt or equity to raise the additional

$5,000,000? Explain.