Balance Sheet Current liabilities $200,000 Common stock, $1 par 50,000 Retained earnings 25,000 Total assets $275,000 Total liabilities and equity $275,000 Income Statement Sales $550,000 All costs except interest 495,000 EBIT $ 55,000 Interest 15,000 EBT $ 40,000 Taxes (40%) 16,000 Net income $ 24,000 Shares outstanding 50,000 Earnings per share $0.48 Price/earnings ratio 18 Market price of stock $8.64

Question

The Howe Computer Company has grown rapidly during the
past 5 years. Recently, its commercial bank urged the company to consider increasing its
permanent financing. Its bank loan under a line of credit has risen to $150,000, carrying a
10% interest rate, and Howe has been 30 to 60 days late in paying trade creditors.

Discussions with an investment banker have resulted in the decision to raise $250,000
at this time. Investment bankers have assured Howe that the following alternatives are
feasible (flotation costs will be ignored):
Alternative 1: Sell common stock at $10 per share.
Alternative 2: Sell convertible bonds at a 10% coupon, convertible into 80 shares of
common stock for each $1,000 bond (i.e., the conversion price is $12.50 per share).
Alternative 3: Sell debentures with a 10% coupon; each $1,000 bond will have 80 warrants
to buy 1 share of common stock at $12.50.
Keith Howe, the president, owns 80% of Howe’s common stock and wants to maintain control
of the company; 50,000 shares are outstanding. The following are summaries of Howe’s
latest financial statements:

 

 

a. Show the new balance sheet under each alternative. For alternatives 2 and 3, show the
balance sheet after conversion of the debentures or exercise of the warrants. Assume
that $150,000 of the funds raised will be used to pay off the bank loan and the rest
used to increase total assets.
b. Show Keith Howe’s control position under each alternative, assuming that he does not
purchase additional shares.
c. What is the effect on earnings per share of each alternative if it is assumed that earnings
before interest and taxes will be 20% of total assets?
d. What will be the debt ratio under each alternative?
e. Which of the three alternatives would you recommend to Keith Howe? Why?

Balance Sheet
Current liabilities
$200,000
Common stock, $1 par
50,000
Retained earnings
25,000
Total assets $275,000
Total liabilities and equity
$275,000
Income Statement
Sales
$550,000
All costs except interest
495,000
EBIT
$ 55,000
Interest
15,000
EBT
$ 40,000
Taxes (40%)
16,000
Net income
$ 24,000
Shares outstanding
50,000
Earnings per share
$0.48
Price/earnings ratio
18
Market price of stock
$8.64
View transcribed image text
Expand

Expert Answer

Want to see the step-by-step answer?

Check out a sample Q&A here.

Want to see this answer and more?

Experts are waiting 24/7 to provide step-by-step solutions in as fast as 30 minutes!*

*Response times may vary by subject and question complexity. Median response time is 34 minutes for paid subscribers and may be longer for promotional offers.
Tagged in
Business
Finance

Accounting and Finance Analysis

Related Finance Q&A

Find answers to questions asked by students like you.

Q: Hello. I'd like the functions in order to calculate the following myself. I am attaching the numbers...

A:   Before tax cost of debt is the yield to maturity (YTM) (rate) on the outstanding bonds of the com...

Q: A project whose machinery and installation cost $15,000, promises a net      stream of savings of $...

A: Given that;The cash flows are:Year 0: -$15,000Year 1: $3,000Year 2: $3,000Year 3: $3,000Year 4: $3,0...

Q: What actions do companies typically take to meet the large debt burdens resultingfrom LBOs?

A: Leverage buyout could be a kind of trade procurement with a huge sum of obligation. For the most par...

Q: You have the opportunity to make an investment that costs $1.000,000. If you make this investment no...

A: Excel Spreadsheet:

Q: Is this a right formula? Forward P/E = Market capitalization/ forecasted income

A: There are two types of P/E ratios 1) Trailing P/E ratio 2) Forward P/E ratio   Trailing P/E ratio te...

Q: Your firm purchases goods from its supplier on terms of 2.3/14, net 40. a. What is the effective an...

A: Part a)Given that;Discount is 2.3 Payment days is 40 Discount period is 14

Q: For this question you need to attach a file in Excel with your calculations. What do we call the cos...

A: IRR is the internal rate of return. It is the rate at which Net present value of the project will be...

Q: Describe the market multiple approach.

A: Answer: A multiple market analysis is a method of financial modelling which assigns a value to an as...

Q: A couple who borrow $60,000 for 25 years at 6%, compounded monthly, must make monthly payments of $3...

A: Calculate the interest amount for first year as follows: Interest = Amount * Interest rate Interest ...

Transcribed Image Text

Balance Sheet Current liabilities $200,000 Common stock, $1 par 50,000 Retained earnings 25,000 Total assets $275,000 Total liabilities and equity $275,000 Income Statement Sales $550,000 All costs except interest 495,000 EBIT $ 55,000 Interest 15,000 EBT $ 40,000 Taxes (40%) 16,000 Net income $ 24,000 Shares outstanding 50,000 Earnings per share $0.48 Price/earnings ratio 18 Market price of stock $8.64