Owakonze Inc. (Owakonze), a privately owned corporation, is in need of ($1,000,000) to finance an expansion of
Question:
Owakonze Inc. (Owakonze), a privately owned corporation, is in need of \($1,000,000\) to finance an expansion of its operations. Management is considering three financing alternatives:
i. Issue 100,000 common shares to a group of private investors for \($10\) per share.
In recent years, dividends of \($0.65\) per share have been paid on the common shares.
ii. Issue 40,000 cumulative preferred shares with an annual dividend of \($2\) per share for \($25\) per share. The preferred shares are redeemable after eight years for \($27\) per share.
iii. Issue a \($1,000,000\) bond with a coupon rate of 7 percent per year and maturity in 12 years.
It’s now late July 2014. Owakonze’s year-end is July 31. Owakonze plans to raise the needed money at the beginning of its 2015 fiscal year, but management wants to know the financial statement effects and implications of each alternative. Owakonze’s accounting department has provided the right-hand side of the balance sheet as of July 31, 2014 and a summarized projected income statement for the year ended July 31, 2015. The projected statements don’t reflect any of the proposed financing alternatives.
One of Owakonze’s existing loans has a covenant that requires the debt-to equity ratio be below 1:1. Owakonze has a tax rate of 15 percent.
Required:
a. Calculate projected net income for Owakonze under the three financing alternatives.
b. Calculate basic earnings per share and return on shareholders’ equity under the three financing alternatives.
c. Prepare a report to Owakonze’s management explaining the effect of each of the financing alternatives on the financial statements. Include in your report a discussion of the pros and cons of each financing alternative. Also, make a recommendation as to which alternative it should choose. Support your recommendation.
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