Problem -
Tamara Retail Inc. must raise $100 million on January 1, 2018 to finance its expansion into a new market. The company will use the money to finance construction of four retail outlets and a distribution center. The stores are expected to open later this year. The CFO has come up with three alternatives for raising the money:
1) Issue $100 million of 8% nonconvertible debt due in 20 years.
2) Issue $100 million of 6% nonconvertible preferred stock (100,000 shares).
3) Issue $100 million of common stock (1 million shares).
The company's internal forecasts indicate the following 2018 year-end amounts before any option is chosen:
$ in millions
Total debt $425
Total shareholders' equity 250
Net income for the year 10
Tamara Retail Inc has no preferred stock outstanding but currently has 10 million shares of common stock outstanding. EN has been declining for the past several years. Earnings in 2017 were $1 per share, which was down f MITI $1.10 during 2016, and management wants to avoid another decline during 2018. One of the company's existing loan agreements requires a debt-to-equity ratio to be less than 2.
Tamara Retail Inc pays taxes at a 35% rate.
Required:
1- Assess the impact of each financing alternative on 2018 EPS and the year-end debt to equity ratio.
2- Which financing alternative would you recommend and why?