RRS Financial Services is considering two plans for raising $900,000 to expand operations. Plan A is to borrow at 5%, and plan B is to issue 300,000 shares of common stock at $3.00 per share. Before any new financing, RRS Financial Services has net income of $650,000 and 225,000 shares of common stock outstanding. Assume you own most of RRS Financial Services’ existing stock. Management believes the company can use the new funds to earn additional income of $800,000 before interest and taxes. RRS Financial Services’ income tax rate is 40%.
1. Analyze RRS Financial Services’ situation to determine which plan will result in the higher earnings per share.
2. Which plan allows you to retain control of the company? Which plan creates more financial risk for the company? Which plan do you prefer? Why? Present your conclusion in a memo to RRS Financial Services’ board of directors.