Please show work Question 2. (20 points) TRANE Corporation plans to raise $4mill
ID: 2600472 • Letter: P
Question
Please show work
Question 2. (20 points) TRANE Corporation plans to raise $4million 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 s0heet 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.
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
$3,200,000
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
$3,200,000
Explanation / Answer
a. New Balance sheet (ALternate-1)
Current Balance Sheet
Additional Cash
2,800,000
Current Liabilities (1,500,000-1,200,000)
$300,000
Other assets
3,200,000
Common Stock, Par $0.10+ new stock
1,040,000
Paid in capital - excess of par
3,960,000
Retained earnings
700,000
Total Assets
$6,000,000
Total claims
$6,000,000
New Balance sheet (Alternate-2)
Current Balance Sheet
Additional Cash
2,800,000
Current Liabilities (1,500,000-1,200,000)
$300,000
Other assets
3,950,000
Long term debt 12%
4,000,000
Common Stock, Par $0.10+ new stock (1,000*50*0.1)
1,005,000
Paid in capital - excess of par (1,000*50*14,9)
745,000
Retained earnings
700,000
Total Assets
$6,750,000
Total claims
$6,750,000
b. Calculate the president's ownership position for both alternatives. He doesn't buy any of the additional shares.
Alternatives
1
2
Number of shares
5,500,000
5,500,000
Total shares
10,400,000
10,050,000
% of ownership = number of shares / total shares *100
53%
55%
c Calculate earnings per share for both alternatives, assuming that EBIT is 12% of total assets.
Total assets
6,000,000
6,750,000
EBIT at 12%
720,000
810,000
Interest
-
(480,000)
EBT
720,000
330,000
Taxes at 30%
(216,000)
(99,000)
Net income
504,000
231,000
Number of shares
10,400,000
10,050,000
EPS
$0.05
$0.02
d. Calculate the debt ratio under both alternatives:
Alternatives
1
2
Total assets
6,000,000
6,750,000
Total debt
300,000
4,300,000
Debt ratio = debt /assets
5%
64%
e. Which alternative do you recommend and why?
The better option will be, where the debt ratio is higher and EPS is lower.
therefore alternate 2 will be better option.
Current Balance Sheet
Additional Cash
2,800,000
Current Liabilities (1,500,000-1,200,000)
$300,000
Other assets
3,200,000
Common Stock, Par $0.10+ new stock
1,040,000
Paid in capital - excess of par
3,960,000
Retained earnings
700,000
Total Assets
$6,000,000
Total claims
$6,000,000