For the year ended June 30, 2007, A.E.G. Enterprises presented the financial statements shown on page 280.
Early in the new fiscal year, the officers of the firm formalized a substantial expansion plan. The plan will increase fixed assets by $190,000,000. In addition, extra inventory will be needed to support expanded production. The increase in inventory is purported to be $10,000,000.
The firm's investment bankers have suggested the following three alternative financing plans:
Plan A: Sell preferred stock at par.
Plan B: Sell common stock at $10 per share.
Plan C: Sell long-term bonds, due in 20 years, at par ($1,000), with a stated interest rate of 16%.
A.E.G. ENTERPRISES
Balance Sheet for June 30, 2007 (in thousands)
Assets
Current assets:
Cash $ 50,000
Accounts receivable 60,000
Inventory 106,000
Total current assets $216,000
Property, plant, and equipment $504,000
Less: Accumulated depreciation 140,000 364,000
Patents and other intangible assets 20,000
Total assets $600,000
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 46,000
Taxes payable 15,000
Other current liabilities 32,000
Total current liabilities $ 93,000
Long-term debt 100,000
Stockholders' equity:
Preferred stock ($100 par, 10% cumulative, 500,000 shares
authorized and issued) 50,000
Common stock ($1 par, 200,000,000 shares authorized,
100,000,000 issued) 100,000
Premium on common stock 120,000
Retained earnings 137,000
Total liabilities and stockholders' equity $600,000
A.E.G. ENTERPRISES
Income Statement
For the Year Ended June 30, 2007
(in thousands except earnings per share)
Sales $936,000
Cost of sales 671,000
Gross profit $265,000
Operating expenses:
Selling $62,000
General 41,000 103,000
Operating income $162,000
Other items:
Interest expense 20,000
Earnings before provision for income tax $142,000
Provision for income tax 56,800
Net income $ 85,200
Earnings per share $ 0.83
a. For the year ended June 30, 2007, compute:
1. Times interest earned 7.1
2. Debt ratio 16 %
3. Debt/equity ratio 18.34
4. Debt to tangible net worth ratio 19%
b. Assuming the same financial results and statement balances, except for the increased assets and financing, compute the same ratios as in (a) under each financing alternative. Do not attempt to adjust retained earnings for the next year's profits.
c. Changes in earnings and number of shares will give the following earnings per share: Plan A-0.73,
Plan B-0.69, and Plan C-0.73. Based on the information given, discuss the advantages and disadvantages of each alternative.
d. Why does the 10% preferred stock cost the company more than the 16% bonds?