SullivanMedical Goods is embarking on a massive expansion. Assume plans call for opening 20 newstores during the next two years. Each store is scheduled to be 30% larger than the company’sexisting locations, offering more items of inventory and with more elaborate displays. Management estimates that company operations will provide $1.0 million of the cash needed forexpansion. Sullivan Medical must raise the remaining $5.5 million from outsiders.The board of directors is considering obtaining the $5.5 million either by borrowing at 6%or by issuing an additional 250,000 shares of common stock. This year the company hasearned $4 million before interest and taxes and has 250,000 shares of $1-par common stockoutstanding. The market price of the company’s stock is $22.00 per share. Assume that incomebefore interest and taxes is expected to grow by 10% each year for the next two years. Thecompany’s marginal income tax rate is 35%.Requirements1. Use Excel to evaluate the effect the two financing alternatives will have on Sullivan’s netincome and earnings per share two years from now.2. Write a memo to Sullivan’s management discussing the advantages and disadvantages ofborrowing and of issuing common stock to raise the needed cash. Which method of raisingthe funds would you recommend?
Sullivan
Medical Goods is embarking on a massive expansion. Assume plans call for opening 20 new
stores during the next two years. Each store is scheduled to be 30% larger than the company’s
existing locations, offering more items of inventory and with more elaborate displays. Management estimates that company operations will provide $1.0 million of the cash needed for
expansion. Sullivan Medical must raise the remaining $5.5 million from outsiders.
The board of directors is considering obtaining the $5.5 million either by borrowing at 6%
or by issuing an additional 250,000 shares of common stock. This year the company has
earned $4 million before interest and taxes and has 250,000 shares of $1-par common stock
outstanding. The market price of the company’s stock is $22.00 per share. Assume that income
before interest and taxes is expected to grow by 10% each year for the next two years. The
company’s marginal income tax rate is 35%.
Requirements
1. Use Excel to evaluate the effect the two financing alternatives will have on Sullivan’s net
income and earnings per share two years from now.
2. Write a memo to Sullivan’s management discussing the advantages and disadvantages of
borrowing and of issuing common stock to raise the needed cash. Which method of raising
the funds would you recommend?
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