Business is going well for David Johns Inc., the company that operates remote parking lots near major airports. The board of directors of this family-owned company believes that David Johns Inc. could earn an additional $1.5 million income before interest and taxes by expanding into new markets. However, the $5 million that the business needs for growth cannot be raised within the family. The directors, who strongly wish to retain family control of the company, must consider issuing securities to outsiders. The directors are considering the three following financing plans:
1- Plan A: to issue 100,000 bonds of 6% interest.
2- Plan B: to issue 100,000 ordinary shares.
3- Plan C: to issue 100,000 non-voting preference shares ($3.75 is the annual dividend paid on each share of preference shares).
Davis Johns Inc. presently has net income of $3.5 million and 1 million of shares of ordinary shares outstanding. The company’s income tax rate is 35%.
REQUIREMENTS.
1- Prepare an analysis to determine which plan will result in the highest earning per share of ordinary share capital.
2- Recommend a plan to the board of directors. Give your reasons.