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Alternative balance sheets

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ORNE Corporation plans to raise $2 million to pay off its existing short-term bank loan of $600,000 and to increase total assets by $1,400,000. The bank loan bears an interest rate of 10 percent. The company's president owns 57.5% percent of the 1,000,000 shares of common stock and wishes to maintain control of the company. The company's tax rate is 30 percent.

The company is considering two alternatives to raise the $2 million: (1) sell common stock at $10 per share, or (2) Sell bonds at a 10 percent coupon, each $1,000 bond carrying 50 warrants to buy common stock at $15 per share.

a. Show the new balance sheet under both alternatives. For Alternatives 2, show the balance sheet after exercise of the warrants.
b. Calculate the president's ownership position for both alternatives. He doesn't buy any of the additional shares.
c. Calculate earnings per share for both alternatives, assuming that EBIT is 10 percent of total assets.
d. Calculate the debt ratio under both alternatives
e. Which alternative do you recommend and why?

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The solution explains how to prepare alternative balance sheets given different financing options

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Annabrook: sell common stock, convertible bonds or debentures?

Annabrooke's 6 Firm has grown rapidly during the past 5 years. Recently, could its commercial bank urge the company to consider increasing its permanent financing? Its bank loan under a line of credit has risen to $250,000, carrying an 8% interest rate. Annabrooke's 6 Firm has been 30 to 60 days late paying trade creditors.

Discussion 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 (floatation costs will be ignored):

Could you please show all calculations in a step-by-step manner? Show all the calculations.

Alternative 1: Sell Common stock at $8.

Alternative 2: Sell convertible bonds at an 8% coupon, each $1000 bond carrying 100 warrants to buy common stock at $10.

Alternative 3: Sell debentures at an 8% coupon, each $1000 bond carrying 100 warrants to buy common stock at $10.

Brian the president, owns 80% of the common stock and wishes to maintain control of the company. One hundred thousand shares are outstanding. The following are extracts of Annabrooke's 6 Firm latest financial statements.

Balance Sheet: Current liabilities: $400,000
Common stock, par $1: 100,000
Retained earnings: 50,000
Total claims: $550,000
Total assets: $550,000

Income statement

Sales $1,100,000
All costs except interest 990,000

EBIT 110,000
Interest 20,000

EBT 90,000
Taxes (40%) 36,000

Shares outstanding 100,000

Earnings $ 0.54

Price/earnings ratio 15.83x

Market price of stock $8.55

A. Show the new balance sheet under each alternative. For Alternative 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 Annabrooke's 6 Firm 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 assumed that profits before interest and taxes will be 20% of total assets?

D. What will be the debt ratio (TL/TA) under each alternative?

E. Which of the three alternatives would you recommend to Annabrooke's 6 Firm, and why?

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