Response to the following problem:
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% notes 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% notes at face amount.
The balance sheet as of the end of the previous fiscal year is as follows:
Mo JAVE o Asls, INC.
Balance sheet
December 31, 2012
| Assets |
|
|
Current assets
|
$10,000,000
|
|
Property, plant, and equipment
|
15,000,000
|
|
Total assets
|
$25,000,000
|
Liabilities and stockholders' Equity
|
|
|
Liabilities
|
$ 7,000,000
|
|
Common stock, $20
|
8,000,000
|
|
Paid-in capital in excess of par
|
300,000
|
|
Retained earnings
|
9,700,000
|
|
Total liabilities and stockholders' equity
|
$25,000,000
|
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.
a. Prepare a table indicating the expected earnings per share on the common stock under each plan. Assume an income tax rate of 25%.
b. (1) Discuss the factors that should be considered in evaluating the two plans. (2) Which plan offers the greater benefit to the present stockholders? Give reasons for your opinion.