Response to the following problem:
The board of directors of Megalopolis Inc. has approved management's recommendation to expand the production facilities. The firm currently manufactures only heavy machinery, but plans are being developed for diversifying the corporation's activities through the production of smaller and more versatile equipment.
The directors are considering the following financing methods raise $2 million of additional capital:
a. Sell $2 million of 12% bonds at face value.
b. Sell $8 preferred shares: 20,000 shares at $100 a share (no other preferred shares are outstanding).
c. Sell another 50,000 shares of common shares at $40 a share (currently 40,000 common shares are outstanding).
Income before interest and income taxes is expected to average $1,000,000 per year following the expansion; the income tax rate is 50%.
Required:
1. Calculate the earnings per common share for each alternative.
2. As representatives of common shareholders, which financing method most likely meets the board of directors' needs?
3. What other factors should the board of directors consider?