Rossi's Tile and Ceramic Company has grown rapidly during the past 5 years. Recently, its commercial bank urged the company to consider increasing its permanent financing. Its bank loan under a line of credit has risen to $600,000, carrying a 7% interest rate. Rossi has been 30 to 60 days late in paying trade creditors.
Discussions with an investment banker have resulted in the decision to raise $900,000 at this time. Investment bankers have assured the firm that the following alternatives are feasible (flotation costs will be ignored):
€¢ Alternative 1: Sell common stock at $8.
€¢ Alternative 2: Sell convertible bonds at a 7% coupon, convertible into 100 shares of common stock for each $1,000 bond (i.e., the conversion price is $10 per share).
€¢ Alternative 3: Sell debentures at a 7% coupon, each $1,000 bond carrying 100 warrants to buy common stock at $10. Aldo Rossi, the president, owns 68% of the common stock and wishes to maintain control of the company. Three hundred thousand shares are outstanding. The following are extracts from Rossi's latest financial statements:

a. Show the new balance sheet under each alternative. For Alternatives 2 and 3, show the balance sheet after conversion of the bonds or exercise of the warrants. Assume that some of the funds raised will be used to pay off the bank loan and the remainder to increase total assets.
b. Show Mr. Rossi's control position under each alternative, assuming that he does not purchase additional shares.
c. What is the effect on earnings per share of each alternative, if it is assumed that profits before interest and taxes will be 20% of total assets?
d. What will be the debt ratio (TL/TA) under each alternative?
e. Which of the three alternatives would you recommend to Rossi, and why?

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Balance Sheet Current liabilities Common stock, par S1 Retained earnings Total claims $1,700,000 300,000 400 Total assets $2,400,000 $2,400,000 ncome Statement Sales All costs except interest $4,580,000 4,100,000 480,000 22,000 458,000 137,400 $320,600 300,000 EBIT Interest EBT Taxes (30%) Net income Shares outstanding Earnings per share Price/earnings ratio Market price of stock 1.07 8.0 × 8.55