Environgard Corporation
INDROCUTION
Environgard formed in 1980 in the Chicago had dominated the air pollution scrubbing equipment market ever since the largest single product, the so2.A threat to their dominance to their scrubber market surfaced recently with the development of new type of scrubber that is both cheaper to purchase and more effective against air pollutants. So, Enviorongard decided to begin plant remodeling which needed approximately $34 million of new capital.
Marcia Hellriegel, Vice president and controller learned that funds may be obtained by 3 alternative methods
1. The company can sell common stock to net dollar 32 per share through investment bankers to general public. Flotation cost of $5 per share involved.
2. The company can privately sell 25 year, 10%bonds to a group of life insurance companies. The bonds would have a sinking fund calling for the retirement by a lottery method of 3%of the original amount of bond issue each year. The bond agreement also requires that the current ratio be maintained at the level of 2:1 and bonds would not be callable for 10 years after which the usual call premium would not be involved. No flotation cost would involve.
3. Third alternative available to company is to sell 6%cumulative preferred stock.
Issue 1. Assuming that the new funds earn the same rate of return currently being earned on firms assets (earnings before interest and taxes/total assets), what would earning per share be for 2007 under each of the three financing methods? Assume that the new outside funds are employed during the whole year of 2007, the sinking fund payment for 2007 is ignored, and retained earnings for 2007 are not employed until 2008. Under which of financing alternatives, EPS is highest and why?
Solution:
Given, New funds earn the same rate of return currently being earned on firms assets (earnings before interest and taxes/total assets
Rate of return = EBIT/total assets
Rate of return of 2006 =
Environgard formed in 1980 in the Chicago had dominated the air pollution scrubbing equipment market ever since the largest single product, the so2.A threat to their dominance to their scrubber market surfaced recently with the development of new type of scrubber that is both cheaper to purchase and more effective against air pollutants. So, Enviorongard decided to begin plant remodeling which needed approximately $34 million of new capital.
Marcia Hellriegel, Vice president and controller learned that funds may be obtained by 3 alternative methods
1. The company can sell common stock to net dollar 32 per share through investment bankers to general public. Flotation cost of $5 per share involved.
2. The company can privately sell 25 year, 10%bonds to a group of life insurance companies. The bonds would have a sinking fund calling for the retirement by a lottery method of 3%of the original amount of bond issue each year. The bond agreement also requires that the current ratio be maintained at the level of 2:1 and bonds would not be callable for 10 years after which the usual call premium would not be involved. No flotation cost would involve.
3. Third alternative available to company is to sell 6%cumulative preferred stock.
Issue 1. Assuming that the new funds earn the same rate of return currently being earned on firms assets (earnings before interest and taxes/total assets), what would earning per share be for 2007 under each of the three financing methods? Assume that the new outside funds are employed during the whole year of 2007, the sinking fund payment for 2007 is ignored, and retained earnings for 2007 are not employed until 2008. Under which of financing alternatives, EPS is highest and why?
Solution:
Given, New funds earn the same rate of return currently being earned on firms assets (earnings before interest and taxes/total assets
Rate of return = EBIT/total assets
Rate of return of 2006 =