Before any new financing, Sammy Ltd. has net income of $250,000 and 200,000 common shares outstanding. Ms. Sammy owns 65% of the shares and therefore has control of the company. Sam is considering two...

Before any new financing, Sammy Ltd. has net income of $250,000 and 200,000 common shares outstanding. Ms. Sammy owns 65% of the shares and therefore has control of the company.

Sam is considering two plans for raising $700,000 for expansion.

• Plan A: Borrow at 5% of capital obtained.


• Plan B: issue 50,000 common shares at $14 each.

Management believes the expansion will generate additional income of $300,000 before interest and taxes. Ltd.’s income tax rate is 25%. Ms. Sammy plans to sell to Jayco Co, her best friend’s company, to raise capital if equity is used. These two have been in business for over 15 years, selling fashion accessories.

Required:

1. Analyze the above plans to determine which one will result in a higher net income; show calculations for costs included. Also indicate which is more favorable.


2. Using the calculations done above in part 1, indicate which option is more favorable after calculating Earnings Per Share.


3. Which plan do you think would/should be choosen? Explain.


4. Which plan creates more financial risk (risk here = inability to pay when due) for the company? Explain.