Carr Industries Must Raise $100 Million on January 1,2012 to Finance

question 41

Essay

Carr Industries must raise $100 million on January 1,2012 to finance its expansion into a new market.The company will use the money to finance construction of four retail outlets and a distribution center.The stores are expected to open later this year.The CFO has come up with three alternatives for raising the money:
1)Issue $100 million of 8% nonconvertible debt due in 20 years.
2)Issue $100 million of 6% nonconvertible preferred stock (100,000 shares).
3)Issue $100 million of common stock (1 million shares).
The company's internal forecasts indicate the following 2012 year-end amounts before any option is chosen:
$\begin{array} { | l | r | } \hline \text { Sin millions } & \\\hline \text { Tatal debt } & 425 \\\hline \text { Total shareholders' equity } & 250 \\\hline \text { Net incane Far the year } & 10 \\\hline\end{array}$
Carr has no preferred stock outstanding but currently has 10 million shares of common stock outstanding.EPS has been declining for the past several years.Earnings in 2011 were $1 per share,which was down from $1.10 during 2010,and management wants to avoid another decline during 2012.One of the company's existing loan agreements requires a debt-to-equity ratio to be less than 2.Carr pays taxes at a 40% rate.
Required:
1.Assess the impact of each financing alternative on 2012 EPS and the year-end debt to equity ratio.
2.Which financing alternative would you recommend and why?

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Definitions:

Tibia

The larger and stronger of the two bones in the lower leg, commonly referred to as the shin bone.

Talus

A bone in the ankle that sits between the heel bone and the two bones of the lower leg, allowing for ankle movement.

Palatine Bones

Bones that form part of the hard palate of the mouth as well as parts of the nasal cavity and eye orbits.

Maxillae

The pair of large facial bones that form the upper jaw and parts of the orbits of the eyes, necessary for chewing and supporting the face.