Question - Learning Objective - Analyzing alternative plans for raising money
First Bank Financial Services is considering two plans for raising $800,000 to expand operations. Plan A is to borrow at 10%, and plan B is to issue 200,000 shares of common stock at $4.00 per share. Before any new financing, First Bank Financial Services has net income of $600,000 and 200,000 shares of common stock outstanding. Assume you own most of First Bank Financial Services' existing stock. Management believes the company can use the new funds to earn additional income of $800,000 before interest and taxes. First Bank Financial Services' income tax rate is 25%.
Requirements
1. Analyze First Bank Financial Services situation to determine which plan will result in higher earnings per share.
2. Which plan results in the higher earnings per share? Which plan allows you to retain control of the company? Which plan creates more financial risk for the company? Which plan do you prefer? Why? Present your conclusion in a memo to First Bank Financial Services board of directors.