Problem:
Annabrooke's 6 Firm has grown rapidly during the past 5 years. Recently, could its commercial bank urge the company to consider increasing its permanent financing? Its bank loan under a line of credit has risen to $250,000, carrying an 8% interest rate. Annabrooke's 6 Firm has been 30 to 60 days late paying trade creditors.
Discussion with an investment banker have resulted in the decision to raise $500,000 at this time. Investment bankers have assured the firm that the following alternatives are feasible (floatation costs will be ignored):
Could you please show all calculations in a step-by-step manner? Show all the calculations.
Alternative 1: Sell Common stock at $8.
Alternative 2: Sell convertible bonds at an 8% coupon, each $1000 bond carrying 100 warrants to buy common stock at $10.
Alternative 3: Sell debentures at an 8% coupon, each $1000 bond carrying 100 warrants to buy common stock at $10.
Brian the president, owns 80% of the common stock and wishes to maintain control of the company. One hundred thousand shares are outstanding. The following are extracts of Annabrooke's 6 Firm latest financial statements.
Balance Sheet: Current liabilities: $400,000
Common stock, par $1: 100,000
Retained earnings: 50,000
Total claims: $550,000
Total assets: $550,000
Income statement
Sales $1,100,000
All costs except interest 990,000
EBIT 110,000
Interest 20,000
EBT 90,000
Taxes (40%) 36,000
Shares outstanding 100,000
Earnings $ 0.54
Price/earnings ratio 15.83x
Market price of stock $8.55
A. Show the new balance sheet under each alternative. For Alternative 2 and 3, show the balance sheet after conversion of the bonds or exercise of the warrants. Assume that half of the funds raised will be used to pay off the bank loan and half to increase total assets?
B, Show Annabrooke's 6 Firm control position under each alternative, assuming that he does not purchase additional shares?
C. What is the effect on earnings per share of each alternative, if it assumed that profits before interest and taxes will be 20% of total assets?
D. What will be the debt ratio (TL/TA) under each alternative?
E. Which of the three alternatives would you recommend to Annabrooke's 6 Firm, and why?