Description
Financing business expansion
You hold a 30% common stock interest in the family-owned business, a vending machine company. Your sister, who is the manager, has proposed an expansion of plant facilities at an expected cost of $6,000,000. Two alternative plans have been suggested as methods of financing the expansion. Each plan is briefly described as follows:
Plan 1. Issue $6,000,000 of 15-year, 8% bonds at face amount.
Plan 2. Issue an additional 100,000 shares of $20 par common stock at $25 per share, and $3,500,000 of 15-year, 8% bonds at face amount.
The balance sheet as of the end of the previous fiscal year is as follows:
Net income has remained relatively constant over the past several years. The expansion program is expected to increase yearly income before bond interest and income tax from $900,000 in the previous year to $1,200,000 for this year. Your sister has asked you, as the company treasurer, to prepare an analysis of each financing plan.
1.Prepare a table indicating the expected earnings per share on the common stock under each plan. Assume an income tax rate of 25%.
2.a. Discuss the factors that should be considered in evaluating the two plans.
b. Which plan offers the greater benefit to the present stockholders? Give reasons for your opinion.
