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:

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 $EPS 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 yourecommend?

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The Severn Company: Balance Sheet as of December 31, 2008 (MIllions of Dollars) $ 900.00 Accounts payable Notes payable to bank $ 172.50 Current assets 255.00 Other current liabilities 225.00 $ 652.50 Total current liabilities Long-term debt (10%) Common stock, $3 par Retained earnings Total liabilities and equity 300.00 Net fixed assets 450.00 60.00 337.50 Total assets $1,350.00 $1.350.00 The Severn Company: Income Statement for Year Ended December 31, 2008 (Millions of Dollars) Sales $2,475.00 Operating costs Earnings before interest and taxes (10%) 2,227.50 $ 247.50 Interest on short-term debt 15.00 Interest on long-term debt Earnings before taxes Federal-plus-state taxes (40%) 30.00 S 202.50 81.00 $ 121.50 Net income The probability distribution for annual sales is as follows: Annual Sales (MIllions of Dollars) $2,250 Probablity 0.30 0.40 2,700 0.30 3,150