ASSIGNMENT WEEK 1
14 – 10 A1 . 3,600,000 X (1 + 10%) = 3,960,000 A2. 3,600,000 / 10,800,000 X 14,400,000 = 4,800,000 A3. 14,400,000 “(8,400,000 X 60%) = 9,360,000 A4. Regular: 3,600,000 X (1 + 10% ) = 3,960,000 Extra : 14,400,000 “ (8,400,000 X 60% )~ ~ “ 3,960,000 = 5,400,000
B
I prefer the pure residual policy (A3). This dividend policy ensures that the company has enough capital to fund profitable projects and minimize its cost of capital through maintaining its optimal capital structure.
C
Yes, a dividend of 9 million is reasonable as it is close to my dividend policy choice.

19 – 6
A The amount being raised is $500,000. This would be used to pay off $250,000 of line of credit and so the accounts payable would reduce to 400,000 – 250,000 = $ 150,000. The remaining 250,000 would be added to cash and so the total assets would increase to 550,000 +250,000 = $800,000
Alternative 2
Under alternative 2,convertible bonds are sold and the balance sheet is after conversion.The number of bonds issues is 500,000/1,000 = 50,000.The price per share is $10.Common stock will increase by the par value of $1 = $1X50,000 = 50,000. The remaining amount of 450,000 would be shown as additional paid in capital.The balance sheet is as under. Total current Liabilities $150,000 Common stock, par $1 150,000 Additional paid –in capital 450,000 Retained earnings 50,000 Total assets $ 800,000 Total claims $800,000
Alternative 3
Under this option both debt and equity will be gotten. The equity will increase in the same way as Alternative 2.The debentures will continue as bonds payable. The total cash raised would be 500,000 +500,000 = 1,000,000. The additional $500,000 will increase assets by $500,000 and will be shown as bonds payable in the balance sheet. Total current Liabilities $150,000 Long-term debt (8%) 500,000 Common stock, par $1 150,000 Additional paid – in capital 450,000 Retained earnings 50,000 Total assets $1,300,000 Total claims $1,300,000

B Original Alt 1 Alt 2 Alt 3
Number of shares by Howland 80,000 80,000 80,000 80,000
Total shares 100,000 100,000 100,000 100,000
Percent ownership 80% 49% 53% 53%
Percent ownership = shares held by Howland /Total shares

C The EBIT would be 800,000 X 20% = 160,000 under alternatives 1 and 2 and 1,300,000 X 20% = 260,000 under alternative 3. Only alternative 2 has debt and the interest amount is 500,000 X 8% = 40,000

Original Alt . 1 Alt.2 Alt. 3
Total assets $550,000 $800,000 $800,000 $1,300,000
EBIT 110,000 160,000 160,000 260,000
Interest 20,000 0 0 40,000
BET 90,000 160,000 160,000 220,000
Taxes (40%) 36,000 64,000 64,000 88,000
Net income $54,000 $96,000 $96,000 $132,000
Number of shares 100,000 162,500 150,000 150,000
Earning per share $0.54 $0.59 $0.64 $0.88
Earning per share = Net Income / Number of shares

D
Total debt = total liabilities = current liabilities + long term debt Original Plan 1 Plan 2 Plan 3
Total debt $400,000 $150,000 $150,000 $600,000
Total Assets 550,000 800,000 800,000 1,300,000
Debt/assets ratio 73% 19% 19% 50%

E
Among the alternative, alternative 1 is inferior to alternative 2 since under alternative 1 there is loss of control (%holding 49%) and the debt ratio is the same and EPS lower. So we discard alternative 1.
Among alternatives 2 and 3, both have the same control,but alternative 3 offers a higher EPS along with a higher financial risk since we debt ratio is higher. The choice would depend on the risk profile of Howland .If Howland is will to take a higher risk for higher EPS than 3 is to be selected else alternative 2 will be selected.