Question

Early in the 2020, Baladna Co. prepared an expansion plan. The plan requires an increase in in both property, plant and equipment and inventory by $190,000,000 and $10,000,000 respectively. The following three alternative financing plans have been suggested by the firm’s investment bankers:

Plan I: issue preferred stock at par.

Plan II: issue common stock at $10 per share.

Plan III: issue a 16% long-term bonds, due in 20 years, at par ($1,000).

1. For the year ended December 31, 2020, compute the following ratios under each financing plan (assuming the same statement balances, except for the increased assets and financing; do not adjust retained earnings for the 2020 profits).

Plan A:

1. Times interest earned

Plan B:

1. Times interest earned

Plan C:

1. Times interest earned

Income Statement

For the Year Ended December 31, 2019

(in thousands except earnings per share)

Sales                                                                                              $936,000

Cost of sales                                                                                    671,000

Gross profit                                                                                   $265,000

Operating expenses:

Selling                                                                    $62,000

General                                                                     41,000          103,000

Operating income                                                                         $162,000

Other items:

Interest expense                                                                               20,000

Earnings before provision for income tax                                   $142,000

Provision for income tax                                                                 56,800

Net income                                                                                   $ 85,200

Earnings per share                                                                            $ 0.83

Answer 1

Times Interest Earned = Operating Income / Interest Expense

Plan A
Since financing is through preferred stock, there will be no change of interest expense
Times Interest Earned = $162000 / 20000 = 8.1 times

Plan B
Since financing is through common stock, there will be no change of interest expense
Times Interest Earned = $162000 / 20000 = 8.1 times

Plan C
Additional Interest = ($190,000,000+10,000,000) x 16% = $32,000,000

Times Interest Earned = $162000 / 52000 = 3.12 times

Since nothing about change in revenues and expenses was given, so data as given is used.