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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881

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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881
Textbook Problem
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Enrietto Aquatic Products’ offer to acquire Fiberglass Products for $2,000,000 cash has been accepted. Enrietto has $1,000,000 of liquid assets that can be converted into cash and plans to either sell common stock or issue bonds to raise the remaining $1,000,000. Before this acquisition, Enrietto’s condensed balance sheet and condensed income statement were as follows:

Chapter 10, Problem 92.3C, Enrietto Aquatic Products offer to acquire Fiberglass Products for $2,000,000 cash has been

Enrietto’s policy is to pay 60% of net income to stockholders as dividends. Enrietto expects to be able to raise the $1,000,000 it needs for the acquisition by selling 50,000 shares of common stock at $20 each or by issuing $1,000,000 of 20-year, 12% bonds. Enrietto expects income from operations to grow by $700,000 after Fiberglass Products has been acquired. (Interest expense will increase if debt is used to finance the acquisition.)

3. If Enrietto sells bonds, what will be the net cash outflows for new interest and for all dividends? (Remember that interest is tax-deductible.)

To determine

Concept introduction:

Stocks (Common Stock and Preferred Stock):

These are two types of the share capital of a company. Common Stock represents the Common shares issued to the shareholders and preferred stock represents the preference shares issued. Preference shares are given preference in payment of dividends and repayment of capital. Common shareholders get the inbuilt right to vote in decisions of the company and preference shareholders generally do not get this right but they may get voting rights with special provisions.

To calculate:

The Cash outflow for New Interest and All Dividends if Company sells Bonds.

Explanation

The Cash outflow for New Interest and All Dividends if Company sells Bonds is calculated as follows:

Bond Option
Income from Operations $ 6,700,000
Less: Interest Expense $ (1,100,000)

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