FINANCING ALTERNATIVES The Severn Company plans to raise a net amount of $270 million to finance new equipment and working capital in early 2009. Two alternatives are being considered: Common stock may be sold to net $60 per share, or bonds yielding 12% may be issued. The balance sheet and income statement of the Severn Company prior to financing are as follows:

The Severn Company: Balance Sheet as of December 31, 2008 (Millions of Dollars)
Current assets	$ 900.00	Accounts payable	$ 172.50
Â	Â	Notes payable to bank	255.00
Â	Â	Other current liabilities	225.00
Â	Â	Total current liabilities	$ 652.50
Net fixed assets	450.00	Long-term debt (10%)	300.00
Â	Â	Common stock, $3 par	60.00
Â	Â	Retained earnings	337.50
Total assets	$1,350.00	Total liabilities and equity	$1,350.00

 

The Severn Company: Income Statement for Year Ended December 31, 2008 (Millions of Dollars)
Sales	$2,475.00
Operating costs	2,227.50
Earnings before interest and taxes (10%)	$ 247.50
Interest on short-term debt	15.00
Interest on long-term debt	30.00
Earnings before taxes	$ 202.50
Federal-plus-state taxes (40%)	81.00
Net income	$ 121.50

 

The probability distribution for annual sales is as follows:

 

Probability	Annual Sales (Millions of Dollars)
0.30	$2,250
0.40	2,700
0.30	3,150

 

Assuming that EBIT equals 10% of sales, calculate earnings per share (EPS) under the debt financing and the stock financing alternatives at each possible level of sales. Then calculate expected EPS and ^σEPS under both debt and stock financing alternatives. Also calculate the debt ratio and the times-interest-earned (TIE) ratio at the expected sales level under each alternative. The old debt will remain outstanding. Which financing method do you recommend?