P 7-7.              For the year ended June 30, 2007, A.E.G. Enterprises presented the financial statements shown on page 280.

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.

 

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%.

A.E.G.  ENTERPRISES

Balance Sheet for June 30, 2007 (in thousands)

Assets

Current assets:

 

 

 

 

 

 

 

 

Cash $   50,000   Accounts receivable 60,000 Inventory 106,000 Total current assets     $216,000 Property, plant, and equipment $504,000     Less: Accumulated depreciation 140,000   364,000 Patents and other intangible assets     20,000 Total assets     $600,000   Â

Liabilities and Stockholders’ Equity Current liabilities:

Accounts payable	$  46,000	Â
Taxes payable	15,000
Other current liabilities	32,000
Total current liabilities	Â	$  93,000
Long-term debt Stockholders’ equity:	Â	100,000

Preferred stock ($100 par,  10% cumulative, 500,000  shares

authorized and issued)                                                                                                                                                                                        50,000

Common stock ($1 par,  200,000,000 shares    authorized,

 

100,000,000 issued)	100,000
Premium on common stock	120,000
Retained earnings	137,000
Total  liabilities and stockholders’ equity	$600,000

A.E.G. ENTERPRISES Income  Statement

For the Year Ended June 30,  2007 (in thousands except earnings per share)

 

Â		Sales	Â	$936,000
		Cost of sales	Â	671,000
		Gross profit Operating expenses: Selling	    $62,000	$265,000
		General	41,000	103,000
		Operating income	Â	$162,000
		Other items: 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	$         0.83
Required	a.	For the year ended June 30, 2007,  compute:	Â	Â
Â	Â	Â	Â	Â

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 financ- ing, 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—0.73, Plan B—0.69, and Plan C—0.73. Based on the information given, discuss the advantages and disadvan- tages of each alternative.

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