Options to Financing a Business Expansion
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A corporation is planning to expand the business and needs $30,000,000. The company believes that a 12-year term loan can be negotiated with a bank at an annual rate of 10%. Alternatively, an investment banking firm has indicated that it is willing to underwrite a common stock issue for a spread of 5%. The corporation currently has 2,000,000 common shares outstanding.
(a) If new shares of the corporation's stock can be sold for $30 per share, how many shares of stock must be sold to net the $30,000,000 that Wheeler needs, assuming out-of-pocket expenses of $600,000?
(b) If the corporation's earnings before interest and taxes increase to $10,000,000 and the applicable tax rate is 34%, what would the earnings per share be under each financing alternative? (Assume annual interest before financing of $1,000,000)
(c) Compute the approximate market price of the common stock if the P/E ratio remains at 10 if new stock is issued but falls to 9.5 if the money is borrowed.
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Solution Summary
A company is considering the different options they have to find funding for an expansion.
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(a) Let X = number of new shares to issue
30,000,000 = 30(1-0.5)X - 600,000
30,000,000 = 28.5X - 600,000
30,000,000 + 600,000 = 28.5 X
30,600,000 = 28.5 X
30,600,000/28.5 = X
X = 1,073,685 shares to be issued
(b) Stock option
Earnings before ...
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