Purchase Solution

Capital Decisions: Equity, Convertible Bonds, Warrants

Not what you're looking for?

Ask Custom Question

The Howland Carpet 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 $250,000, carrying an 8 percent interest rate. Howland has been 30 to 60 days late in paying trade creditors.

Discussions 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 (flotation costs will be ignored):
Alternative 1: Sell common stock at $8.
Alternative 2: Sell convertible bonds at an 8 percent coupon, convertible into 100 shares of common stock for each $1,000 bond (that is, the conversion price is $10 per share).
Alternative 3: Sell debentures at an 8 percent coupon, each $1,000 bond carrying 100 warrants to buy common stock at $10.

John L. Howland, the president, owns 80 percent of the common stock and wishes to maintain control of the company. One hundred thousand shares are outstanding. The following are extracts of Howland's latest financial statements:

> Balance Sheet

Total assets $550,000

Current Liabilities $400,000
Common stock par $1 $100,000
Retained earnings $50,000
Total claims $550,000

> Income Statement

Sales $1,100,000
All costs except interest $990,000
EBIT $110,000
Interest $20,000
EBT $90,000
Taxes $36,000
Net Income $54,000

Shares outstanding 100,000
Earnings per share $0.54
Price/earnings ratio 15.83x
Market price of stock $8.55

> Questions:

a. Show the new balance sheet under each alternative. For those Alternatives 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 Mr. Holand's 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 is assumed that profits before interest and taxes will be 20 percent of total assets?
d. What will be the debt ratio under each alternative?
e. Which of the three alternatives would you recommend to Howland, and why?

Purchase this Solution
Solution Summary

This post sets up a capital structure decisions problem in Excel. The effect on control position, EPS and debt ratio is analyzed for the three capital raising alternatives.

Purchase this Solution
Free BrainMass Quizzes
Managing the Older Worker

This quiz will let you know some of the basics of dealing with older workers. This is increasingly important for managers and human resource workers as many countries are facing an increase in older people in the workforce

Introduction to Finance

This quiz test introductory finance topics.

Organizational Leadership Quiz

This quiz prepares a person to do well when it comes to studying organizational leadership in their studies.

Employee Orientation

Test your knowledge of employee orientation with this fun and informative quiz. This quiz is meant for beginner and advanced students as well as professionals already working in the HR field.

Marketing Research and Forecasting

The following quiz will assess your ability to identify steps in the marketing research process. Understanding this information will provide fundamental knowledge related to marketing research.

View More Free Quizzes
Related BrainMass Solutions

  • Warrant vs. Convertibles

    Convertibles If you had a new firm of your own, which would you use to raise capital (warrants or convertibles)? And, why? I will use convertible bonds.

  • Why is it important to keep paid-in capital separate from earned capital?

    Some companies issued convertible preferred share, convertible bonds, or warrants in which they can be converted to common shares.

  • Convertible bonds and stock warrants

    Since the bonds are convertible bonds, there is no relevance of the price if the bonds were not convertible. 3.

  • Long-term financing instruments and strategies

    to which will be convertible into equity after few years.

  • Homework Assistance

    a) 87.5 b) 17.5 c) 50.0 d) 45.00 e) none of the above Convertible bonds are: a) considered equity on the balance sheet b) similar in risk to the company's common stock c) riskier than the company's common stock d) less risky than

  • Debt and Assets Analysis

    Based on this analysis, would you make an investment in the company's 5% convertible bonds? Explain. (C) Assume you want to compare Sepracor to an IFRS company like Merck (which issues nonconvertible debt with detachable warrants).

  • Paid-in Capital vs Earned Capital

    Companies issue convertible preferred shares, convertible bonds, or warrants.

  • Inida's Capital Sources

    Restricted Covenants Issue Convertible Debenture It is issuing of convertible debentures to which will be convertible into equity after few years. It involves selling of ordinary shares in future at a higher price.

  • Similarities and differences between convertible debt

    Stocks are forms of equity, not debt instruments. 3. They are both utilized by an issuing company to raise additional funds or capital. Basic rights of stockholders of a corporation: 1.

View More Related Solutions