For the year ended June 30, 2009, A.E.G. Enterprises presented the financial statements. Early in the new fiscal year, the officers of the firm formalized a substantial expansion plan. The plan will increase fixed assets by $190 million. In addition, extra inventory will be needed to support expanded production. The increase in inventory is purported to be $10 million.
The firm’s investment bankers have suggested the following three alternative financing plans:
Plan A: Sell preferred stock at par, 5%.
Plan B: Sell common stock at $10 per share.
Plan C: Sell long term bonds, due in 20 years, at par ($1,000), with a stated interest rate of 8%.
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A.E.G. ENTERPRISES |
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Assets |
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Current assets: |
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Cash |
$50,000 |
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Accounts receivable |
60,000 |
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Inventory |
106,000 |
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Total current assets |
$216,000 |
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Property, plant, and equipment |
$504,000 |
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Less: Accumulated depreciation |
140,000 |
364,000 |
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Patents and other intangible assets |
20,000 |
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Total assets |
$600,000 |
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Liabilities and Stockholders’ Equity |
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Current liabilities: |
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Accounts payable |
$46,000 |
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Taxes payable |
15,000 |
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Other current liabilities |
32,000 |
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Total current liabilities |
$93,000 |
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Long term debt |
100,000 |
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Stockholders’ equity: |
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Preferred stock ($100 par, 5% cumulative, 500,000 shares authorized and issued) |
50,000 |
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Common stock ($1 par, 200,000,000 shares authorized, 100,000,000 issued) |
100,000 |
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Premium on common stock |
120,000 |
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Retained earnings |
137,000 |
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Total liabilities and stockholders’ equity |
$600,000 |
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A.E.G. ENTERPRISES |
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Sales |
$936,000 |
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Cost of sales |
671,000 |
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Gross profit |
$265,000 |
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Operating expenses: |
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Selling |
$62,000 |
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General |
41,000 |
103,000 |
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Operating income |
$162,000 |
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Other items: |
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Interest expense |
20,000 |
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Earnings before provision for income tax |
$142,000 |
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Provision for income tax |
56,800 |
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Net income |
$85,200 |
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Earnings per share |
$0.83 |
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Required
a. For the year ended June 30, 2009, compute:
1. Times interest earned
2. Debt ratio
3. Debt/equity ratio
4. Debt to tangible net worth ratio
b. Assuming the same financial results and statement balances, except for the increased assets and financing, compute the same ratios as in (a) under each financing alternative. Do not attempt to adjust retained earnings for the next year’s profits.
c. Changes in earnings and number of shares will give the following earnings per share: Plan A— 0.73, Plan B—0.69, and Plan C—0.73. Based on the information given, discuss the advantages and disadvantages of each alternative.
d. Why does the 5% preferred stock cost the company more than the 8% bonds?