The Board of Directors of Bobcat Corporation Is Considering Two

question 13

Essay

The board of directors of Bobcat Corporation is considering two plans for financing the purchase of new plant equipment. Plan #1 would require the issue of $ 4,000,000, 6%, 20-year bonds at face value. Plan #2 would require the issue of 200,000 common shares for $ 20 per share. Bobcat Corporation currently has 100,000 common shares issued at a book value of $ 20 each and retained earnings of $ 750,000. The income tax rate is expected to be 30%. Assume that income before interest and income taxes is expected to be $ 800,000 if the new factory equipment is purchased. Assume that the debt or equity will be issued at the beginning of the year.
Instructions
a) Prepare a schedule that shows the expected profit, earnings per share, and return on equity (using year-end balances) under each of the plans that the board of directors is considering.
b) If the board of directors' stated goal is to maximize the common shareholders' return, which alternative is preferable? If the board's stated goal is to maximize solvency, which alternative is preferable?

---

Definitions:

Total Utility

The total satisfaction a consumer gets from consuming a certain quantity of goods or services.

Demand Curves

A graphical representation showing the relationship between the price of a good or service and the quantity demanded by consumers, typically downward sloping.

Purchasing Power

The quantity of goods or services that a person or entity can buy with a given amount of currency.

Income Effect

Income Effect describes how a change in an individual's income affects their purchasing behavior, impacting the quantity of goods and services they can afford.