(Learning Objective 5: Analyze alternative plans for raising money) Bondwell Financial Services is considering two plans for raising $500,000 to expand operations. Plan A is to borrow at 6%, and plan B is to issue 100, 000 shares of common stock at $5.00 per share. Before any new financing, Bondwell has net income of $200,000 and 100,000 shares of common stock outstanding. Assume you own most of Bondwell’s existing stock. Management believes the company can use the new funds to earn additional income of $400,000 before interest and taxes. Bondwell’s income tax rate is 30%.
Requirements
1. Analyze Bondwell’s situation to determine which plan will result in the higher earnings per share.
2. Which plan allows you to retain control of the company? Which plan creates more financial risk for the company? Which plan do you prefer? Why?
Want to see the full answer?
Check out a sample textbook solutionChapter 10 Solutions
Financial Accounting (12th Edition) (What's New in Accounting)
Additional Business Textbook Solutions
Horngren's Accounting (12th Edition)
Principles of Accounting Volume 1
Horngren's Cost Accounting: A Managerial Emphasis (16th Edition)
Managerial Accounting (5th Edition)
Cost Accounting (15th Edition)
Horngren's Financial & Managerial Accounting, The Financial Chapters (Book & Access Card)
- Rustic Campsites, Incorporated, is trying to decide between the following two alternatives to finance its new $34 million gaming center. a. Issue $34 million, 6% note. b. Issue 1 million shares of common stock for $34 per share with expected annual dividends of $2.04 per share. Required: 1. Assuming the note or shares of stock are issued at the beginning of the year, complete the income statement for each alternative. 2. Answer the following questions for the current year: (a) By how much are interest payments higher if issuing the note? (b) By how much are dividend payments higher by issuing stock? (c) Which alternative results in higher earnings per share? Complete this question by entering your answers in the tabs below. Required 1 Required 2 Assuming the note or shares of stock are issued at the beginning of the year, complete the income statement for each alternative. (Enter your answers in dollars, not millions (ie, $5.5 million should be entered as 5,500,000). Round your…arrow_forwardJN Electronics is considering two plans for raising $1,000,000 to expand operations. Plan A is to issue 10% bonds payable, and plan B is to issue 200,000 shares of common stock. Before any new financing, JN Electronics has net income of $400,000 and 300,000 shares of common stock outstanding. Management believes the company can use the new funds to earn additional income of $800,000 before interest and taxes. The income tax rate is 21%. Analyze the JN Electronics situation to determine which plan will result in higher earnings per share. Begin by completing the analysis below for plan A, then plan B. Plan A: Issue $1,000,000 of 10% Bonds Payable Net income before new project Expected income on the new project before interest and income tax expenses Less: Interest expense Project income before income tax Less: Income tax expense Project net income Net income with…arrow_forwardCompany A pays out all available earnings as dividends. Company A is is entirely equity financed and is borrowing money to repurchase shares. Company A has 550,000 shares outstanding and Acme is expected to generate $2,500,000 in EBIT every year for the foreseeable future. Company A shareholders require an 8% return on investment. If Company A borrows money, it will have to pay a 4% interest annually on debt Company A wants to borrow money to repurchase shares such that Company A shareholders achieve a return on equity (ROE) of 15%. How much money does Acme need to borrow to repurchase shares?arrow_forward
- Penny Arcades, Incorporated, is trying to decide between the following two alternatives to finance its new $35 million gaming center. a. Issue $35 million, 7% note b. Issue 1 million shares of common stock for $35 per share with expected annual dividends of $2.45 per share. Required: 1. Assuming the note or shares of stock are issued at the beginning of the year, complete the income statement for each alternative. 2. Answer the following questions for the current year (a) By how much are interest payments higher if issuing the note? (b) By how much are dividend payments higher by issuing stock? (c) Which alternative results in higher earnings per share? Complete this question by entering your answers in the tabs below. Required 1 Required 2 Answer the following questions for the current year: (a) By how much are interest payments higher if issuing the note? (b) By how much are dividend payments higher by issuing stock? (c) Which alternative results in higher earnings per share? (Enter…arrow_forwardThis is a multipart problem. Students must complete each part to receive full credit. Also, students must detail all steps and calculations. Zero credit will be awarded if you do not detail all of your steps and calculations. Scott Inc. has a target capital structure consisting of 50% debu, 20% preferred stock, and 30% common stock. Scott Inc. issued 10-year 6.2% semiannual coupon bonds that sell for $905. Scott Inc. also has 1 million preferred shares outstanding with a dividend rate of 9.75%, a face value of $100, and a selling price of $115. Additionally, Scott Inc. has 6 million common shares outstanding and is a constant growth firm that expects to pay a dividend of $2.05 on their common stock. Scott Inc.'s common stock currently sells for $24.50 per share and has a growth rate of 4%. Flotation costs on new common stock would be 10% and the firm's marginal tax rate is 25%. a. What is Scott Inc.'s WACC assuming they can use retained earnings to fund their capital budget? b. Scott…arrow_forwardYou are investigating the expansion of your business and have sought out two avenues for the sourcing of funds for the expansion. The first (Plan A) is an all-ordinary-share capital structure. $1 million would be raised by selling 250,000 shares at $4 each. Plan B would involve the use of financial leverage. $700,000 would be raised issuing bonds with an effective interest rate of 13% (per annum). Under this second plan, the remaining $300,000 would be raised by selling 75,000 shares at $4 price per share. The use of financial leverage is considered to be a permanent part of the firm's capitalisation, so no fixed maturity date is needed for the analysis. A 30% tax rate is appropriate for the analysis. REQUIRED: a) Find the EBIT indifference level associated with the two financing plans using an EBIT-EPS graph. Check your results algebraically. b) A detailed financial analysis of the firm's prospects suggests that the long-term earnings before interest and taxes (EBIT) will be $110,000…arrow_forward
- Assume you have just been hired as business manager of Sunbucks, a coffee shop located adjacent to campus. The firm is currently financed with 90% equity and 10% debt; it has 50,000 shares outstanding; and PO = $9.93 per share. The management group owns about 50 percent of the stock, and the stock is traded in the over-the-counter market. The company's EBIT was $100,000 last year, and since the university's enrollment is capped, EBIT is expected to remain constant (in real terms) over time. Since no expansion capital will be required, Sunbucks plans to pay out all earnings as dividends. You suggested to your new boss that the firm should engage in a capital restructure by issuing more debt and use the proceeds to repurchase stocks. Your boss encouraged you to pursue the idea. As a first step, assume that you obtained from the firm's investment banker the following estimated costs of debt for the firm at different capital structures: % Financed With Debt Rd 0% --- 10 9% 45 9.5% 60 14%…arrow_forward Assume you have just been hired as business manager of EdiPizza, a pizza restaurant located adjacent to campus. The company’s EBIT was GH¢500,000 last year, and since the university’s enrollment is capped, EBIT is expected to remain constant (in real terms) over time. Since no expansion capital will be required, EdiPizza plans to pay out all earnings as dividends. The management group owns about 50% of the stock, and the stock is traded in the over-the counter-market. The firm is currently financed with all equity; it has 100,000 shares outstanding; and price of stock is GH¢25 per share. When you took your MBA corporate finance course, your instructor stated that most firms’ owners would be financially better off if the firms used some debt. When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firm’s investment banker the following estimated costs of debt for the firm at different capital structures:…arrow_forwardAssume you have just been hired as business manager of EdiPizza, a pizza restaurant located adjacent to campus. The company’s EBIT was GH¢500,000 last year, and since the university’s enrollment is capped, EBIT is expected to remain constant (in real terms) over time. Since no expansion capital will be required, EdiPizza plans to pay out all earnings as dividends. The management group owns about 50% of the stock, and the stock is traded in the over-the counter-market. The firm is currently financed with all equity; it has 100,000 shares outstanding; and price of stock is GH¢25 per share. When you took your MBA corporate finance course, your instructor stated that most firms’ owners would be financially better off if the firms used some debt. When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firm’s investment banker the following estimated costs of debt for the firm at different capital structures: Percent…arrow_forward
- Coldstream Corp. is comparing two different capital structures. Plan I would result in 10,000 shares of stock and $100,000 in debt. Plan II would result in 5,000 shares of stock and $200,000 in debt. The interest rate on the debt is 6 percent. a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $60,000. The all-equity plan would result in 15,000 shares of stock outstanding. What is the EPS for each of these plans? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EPS Plan I $ Plan II $ All equity $ b. In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? (Do not round intermediate calculations.) EBIT Plan I and all-equity $ Plan II and all-equity $ c. Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.) EBIT…arrow_forwardAn enterprise owner is considering three options to raise funds for his business activities, each with a different source of capital: • option I-business activities financed exclusively with equity of $600,000, • option II equity amounts to $450,000, the remaining $150,000 is borrowed from a bank at the annual rate of 7.6%, option III equity amounts to $350,000, the remaining $250,000 is borrowed from a bank at the annual rate of 10.4%. The annual net sales revenue is expected to reach $760,000 with total operating costs being $687,000. The enterprise pays 19% income tax. Based on the information provided, determine: return on equity depending on the adopted financing option and its increase (AROE) possible to obtain due to using the debt, ● the degree of financial leverage for each financing option, .threshold EBIT and the threshold return on equity needed for financial leverage to work.arrow_forwardAssume that you have just been hired as business manager of Campus Deli(CD), which is located adjacent to the campus. Its Free Cash Flow(FCF) is $30,000. Because the university’s enrollment is capped, FCF is expected to be constant over time. Because no expansion capital is required, CD pays out all earnings as dividends. CD currently has no debt—it is an all-equity firm—and its 100,000 shares outstanding. The firm’s federal-plus-state tax rate is 40%.On the basis of statements made in your finance text, you believe that CD’s shareholders would be better off if some debt financing was used. When you suggested this to your new boss, she encouraged you to pursue the idea but to provide support for the suggestion.In today’s market, the risk-free rate is 6% and the market risk premium is 6%. CD’s unlevered beta is 1.0. CD currently has no debt, so its cost of equity (and WACC) is 12%. If the firm was recapitalized, debt would be issued and the borrowed funds would be used to repurchase…arrow_forward
- AccountingAccountingISBN:9781337272094Author:WARREN, Carl S., Reeve, James M., Duchac, Jonathan E.Publisher:Cengage Learning,Accounting Information SystemsAccountingISBN:9781337619202Author:Hall, James A.Publisher:Cengage Learning,
- Horngren's Cost Accounting: A Managerial Emphasis...AccountingISBN:9780134475585Author:Srikant M. Datar, Madhav V. RajanPublisher:PEARSONIntermediate AccountingAccountingISBN:9781259722660Author:J. David Spiceland, Mark W. Nelson, Wayne M ThomasPublisher:McGraw-Hill EducationFinancial and Managerial AccountingAccountingISBN:9781259726705Author:John J Wild, Ken W. Shaw, Barbara Chiappetta Fundamental Accounting PrinciplesPublisher:McGraw-Hill Education