For the year ended June 30, 2001, A.E.G. Enterprises presented the financial statements shown on the next page.

Early in the new fiscal year, the officers of the firm formalized a substantial expansion plan. The plan will increase fixed assets by $190,000,000. In addition, extra inventory will be needed to support expanded production. The increase in inventory is purported to be $10,000,000.

A.E.G. ENTERPRISES Balance Sheet for June 30, 2001 (In thousands)
Assets	Â	Â
Current assets:	Â	Â
Cash	$ 50,000	Â
Accounts receivable	60,000	Â
Inventory	106,000	Â
Total current assets	Â	Â
Property, plant, and equipment	$504,000	Â
Less: accumulated depreciation	140,000	364,000
Patents and other intangible assets	Â	20,000
Total assets	Â	$600,000
Liabilities and Stockholders’ Equity	Â	Â
Current liabilities:	Â	Â
Accounts payable	$ 46,000	Â
Taxes payable	15,000	Â
Other current liabilities	32,000	Â
Total current liabilities	Â	$ 93,000
Long-term debt	Â	100,000
Stockholders’ equity:	Â	Â
Preferred stock ($100 par, 10% cumulative, 500,000 shares	Â	Â
authorized and issued)	Â	50,000
Common stock ($1 par, 200,000,000 shares authorized,	Â	Â
100,000,000 issued)	Â	100,000
Premium on common stock	Â	120,000
Retained earnings	Â	137,000
Total liabilities and stockholders’ equity	Â	$600,000
Â	Â	Â

 

A.E.G. ENTERPRISES Income Statement For the Year Ended June 30, 2001 (In thousands except earnings per share)
Sales	Â	$936,000
Cost of sales	Â	671,000
Gross profit	Â	$265,000
Operating expenses	Â	Â
Selling	$ 62,000	Â
General	41,000	103,000
Operating income	Â	$162,000
Other items:	Â	Â
Interest expense	Â	20,000
Earnings before provision for income tax	Â	$142,000
Provision for income tax	Â	56,800
Net income	Â	$ 85,200
Earnings per share	Â	$ .83

The firm’s investment bankers have suggested the following three alternative financing plans:

Plan A: Sell preferred stock at par.

Plan B: Sell common stock at $10 per share.

Plan C: Sell long-term bonds, due in 20 years, at par ($1,000), with a stated interest rate of 16%.

Required a. For the year ended June 30, 2001, compute:

1. Times interest earned

2. Debt ratio

3. Debt/equity ratio

4. Debt to tangible net worth ratio

b. Assuming the same financial results and statement balances, except for the increased assets and financing, compute the same ratios as in (a) under each financing alternative. Do not attempt to adjust retained earnings for the next year’s profits.

c. Changes in earnings and number of shares will give the following earnings per share: Plan A—.73 Plan B—.69 Plan C—.73. Based on the information given, discuss the advantages and disadvantages of each alternative.

d. Why does the 10% preferred stock cost the company more than the 16% bonds?