TRANE Corporation plans to raise $4 million to pay off its existing short-term b
ID: 2807561 • Letter: T
Question
TRANE Corporation plans to raise $4 million to pay off its existing short-term bank loan of $1.2 million and to increase total assets by $2,800,000. The bank loan bears an interest rate of 11 percent. The company's president owns 55% of the 10,000,000 shares of common stock and wishes to maintain control of the company. The company's tax rate is 30 percent. Balance sheet information is shown below. The company is considering two alternatives to raise the $4 million: (1) sell common stock at $10 per share, or (2) Sell bonds at a 12% 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 12% of total assets.
d. Calculate the debt ratio under both alternatives
e. Which alternative do you recommend and why?
Current Balance Sheet Current Liabilities $1,500,000 Common Stock, par $0.10 $1,000,000 Retained Earnings $700,000 TOTAL Assets $3,200,000 TOTAL Claims $3,200,000Explanation / Answer
a. ALTERNATIVE 1 SELL COMMON STOCK AT $ 10 PER SHARE Number of shares sold=4000000/10=400000 BALAMCE SHEET ASSETS: Total Assets $6,000,000 (3200000+2800000) LIABILITIES: A Current liabilities $300,000 (1500000-1200000) Shareholders equity B Common stock , par $0.10 $ 1,040,000 (1000000+400000*0.1) C Additional paid in capital $ 3,960,000 (400000*9.9) D Retained earnings $700,000 E=B+C+D Total shareholders equity $ 5,700,000 F=A+E Total liabilities & shareholders equity $6,000,000 ALTERNATIVE 2 SELL BONDS AT 12% COUPON WITH WARRANTS Amount received per bond=$1000+50*15= $ 1,750 Number of bonds to be sold= 2286 (4000000/1750) Amount received from $1000 bonds $2,286,000 (2286*1000) Number of shares issued 114,300 (2286*50) Amount received from conversion of warrants $ 1,714,500 (2286*50*15) Total amount received $ 4,000,500 BALAMCE SHEET ASSETS: Total Assets $6,000,000 (3200000+2800000) LIABILITIES: A Current liabilities $299,500 (1500000-1200500) B Bonds payable $2,286,000 C Total Liabilities $2,585,500 Shareholders equity D Common stock , par $0.10 $ 1,011,430 (1000000+114300*0.1) E Additional paid in capital $ 1,703,070 (114300*14.9) F Retained earnings $700,000 G=D+E+F Total shareholders equity $ 3,414,500 H=C+G Total liabilities & shareholders equity $6,000,000 b PRESIDENTS OWNERSHIP POSITION Alternative 1 A Total number of shares 10400000 B Presidents holding 5500000 C=B/A Percentage of Presidents holding 52.88% Alternative 2 A Total number of shares 10114300 B Presidents holding 5500000 C=B/A Percentage of Presidents holding 54.38% c EARNING PER SHARE Alternative 1 A EBIT= 12% of 6000000 $ 720,000 B Interest on bank loan $33,000 (0.11*300000) C=A-B Earning Before Tax $ 687,000 D=C*0.3 Tax $ 206,100 E=C-D After tax earning $ 480,900 F Number of shares outstanding 10400000 G=E/F Earning per share $ 0.05 Alternative 2 A EBIT= 12% of 6000000 $ 720,000 B Interest on bank loan $32,945 (0.11*299500) C Interest on Bond $274,320 (0.12*2286000) D=A-B-C Earning Before Tax $ 412,735 E=D*0.3 Tax $ 123,821 F=D-E After tax earning $ 288,915 G Number of shares outstanding 10114300 H=F/G Earning per share $ 0.03 CALCULATION OF DEBT RATIO Alternative 1 A Total Liabilities $300,000 B Total assets $6,000,000 c=A/B Debt Ratio 0.05 Alternative 2 A Total Liabilities $2,585,500 B Total assets $6,000,000 c=A/B Debt Ratio 0.430916667
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.