The Howland Carpet Company has grown rapidly during the past 5 years. Recently, its commercial bank urged the?
• Alternative 1: Sell common stock at $8.
• Alternative 2: Sell convertible bonds at an 8 percent coupon convertible into 100 shares of common stock for each $1,000 bond (that is, the conversion price is $10 per share).
• Alternative 3: Sell debentures at an 8 percent coupon, each $1,000 bond carrying 100 warrants to buy common stock at $10. John L. Howland, the president, owns 80 percent of the common stock and wishes to maintain control of the company. One hundred thousand shares are outstanding. The following are extracts of Howland’s latest financial statements:
a. Show the new balance sheet under each alternative. For Alternatives 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 Mr. Howland’s 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 is assumed that profits before interest and taxes will be 20 percent of total assets?
d. What will be the debt ratio under each alternative?
e. Which of the three alternatives would you recommend to Howland, and why?