inanCing alternatives The Howe Computer Company has grown rapidly during the past 5 years. Recently, its commercial bank urged the company to consider increasing its permanent financing. Its bank loan under a line of credit has risen to $150,000, carrying a 10% interest rate, and Howe has been 30 to 60 days late in paying trade creditors. Discussions with an investment banker have resulted in the decision to raise $250,000 at this time. Investment bankers have assured Howe that the following alternatives are feasible (flotation costs will be ignored): Alternative 1: Sell common stock at $10 per share.Alternative 2: Sell convertible bonds at a 10% coupon, convertible into 80 shares of common stock for each $1,000 bond (i.e., the conversion price is $12.50 per share). Alternative 3: Sell debentures with a 10% coupon; each $1,000 bond will have 80 war- rants to buy 1 share of common stock at $12.50. Keith Howe, the president, owns 80% of Howe’s common stock and wants to maintain con- trol of the company; 50,000 shares are outstanding. The following are summaries of Howe’s latest financial statements:
FinanCing alternatives The Howe Computer Company has grown rapidly during the past 5 years. Recently, its commercial bank urged the company to consider increasing its permanent financing. Its bank loan under a line of credit has risen to $150,000, carrying a 10% interest rate, and Howe has been 30 to 60 days late in paying trade creditors.
Discussions with an investment banker have resulted in the decision to raise $250,000 at this time. Investment bankers have assured Howe that the following alternatives are feasible (flotation costs will be ignored):
Alternative 1: Sell common stock at $10 per share.
Alternative 2: Sell convertible bonds at a 10% coupon, convertible into 80 shares of
common stock for each $1,000 bond (i.e., the conversion price is $12.50 per share).
Alternative 3: Sell debentures with a 10% coupon; each $1,000 bond will have 80 war- rants to buy 1 share of common stock at $12.50.
Keith Howe, the president, owns 80% of Howe’s common stock and wants to maintain con- trol of the company; 50,000 shares are outstanding. The following are summaries of Howe’s latest financial statements:
QUESTIONS:
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Show the new
balance sheet under each alternative. For alternatives 2 and 3, show the balance sheet after conversion of the debentures or exercise of the warrants. Assume that $150,000 of the funds raised will be used to pay off the bank loan and the rest used to increase total assets. -
Show Keith Howe’s control position under each alternative, assuming that he does not purchase additional shares.
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What is the effect on earnings per share of each alternative if it is assumed that earn- ings before interest and taxes will be 20% of total assets?
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What will be the debt ratio under each alternative?
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Which of the three alternatives would you recommend to Keith Howe? Why?
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